Major currencies’ valuations should correlate to their yields, but lately they are diverging. Most G10 currencies are significantly above what yield differentially would suggest. Last week’s hawkish comments of the European Central Bank pushed EUR/USD above 1.20, its highest since the ECB started its quantitative easing.
Markets underestimate the US Federal Reserve’s commitment to stay ahead of inflation. As consumer prices increase – more quickly than is generally expected – interest-rate correlations will snap back into place, forcing a USD rally, especially against JPY, EUR and CHF.