As the yield on U.S. Treasury bonds soared and the dollar strengthened, the euro fell to its weakest level in 17 months, further widening the gap between the dollar and the European financial environment.

EUR / USD fell below $1.123, while the US Dollar Index rose by about 0.6%. Meanwhile, the yield on 10-year US Treasury bonds briefly reached 5.34%, the highest level since 2002.

The reason this trend is important is that the euro has the largest weight in the US dollar index. Therefore, a weakening of the euro will further strengthen the overall strength of the US dollar and tighten the conditions for commodities, emerging markets, and other assets that are sensitive to the US dollar.

5.3% U.S. Treasury yield drives the dollar stronger

The main driving factor is the yield advantage provided by U.S. government debt.

Higher U.S. Treasury yields increase the returns that investors can obtain from holding assets denominated in dollars, which may attract global funds to flow into the United States and increase the demand for the dollar.

The benchmark 10-year yield reached 5.342%, continuing the sell-off in the bond market, and this round of selling off led to the largest quarterly increase since 1994.

This relationship explains why, even if the Federal Reserve does not immediately adjust interest rates, the yield on U.S. Treasury bonds can still affect currencies, stocks, and crypto assets.

European bond market pressures

The euro is also facing pressure from within the European bond market itself.

As investors become more concerned about fiscal risks, the yield on France's 10-year government bonds has risen to 5%, and the yield spread with German bonds is also widening. The long-term borrowing costs in the UK and Japan have also reached multi-decade highs.

Meanwhile, Brent crude oil, priced near $100 per barrel, continues to maintain high inflationary pressures for energy-importing economies. The combination of rising oil prices and climbing U.S. Treasury yields has already weighed on various global currencies.

This also makes investors more inclined to hold US dollars during periods of market stress.

Can the euro rebound?

The short-term outlook depends to a large extent on whether U.S. yields will continue to remain above 5%.

If U.S. Treasury yields decline significantly, the advantage of the dollar may weaken, and EUR / USD are expected to rebound. The slowdown in U.S. inflation has reduced market expectations for an immediate interest rate hike by the Federal Reserve, but long-term yields are still driven by inflation risks, government borrowing, and a large supply of bonds.