EUR/USD charts bearish outside-day as Italy-German yield differential hits 5.5-year high

• The EUR/USD created a bearish outside-day yesterday, signaling the recovery rally has likely ended.
• The Italy-German yield differential hit 5.5-year high, reflecting rising concerns over Italy’s budget.
• The EUR could drop sharply if the European Union takes Italy to task over the budget deficit.

The EUR/USD is on the defensive ahead of the European Union’s official response to Italy’s draft budget.

The common currency charted a bearish outside-day candle yesterday, signaling the recovery rally from the recent low of 1.1215 likely ended at the high of 1.1472 yesterday.  

The sell-off was likely triggered by the rise in Italian sovereign yields. Notably, the spread between the 10-year Italian government bond yield and its German counterpart rose to 327 basis points yesterday – the highest level since April 4, 2013.

The fresh multi-year highs on the Italy-German yield spread reflects rising concerns that the European Union may launch disciplinary procedures against Italy in response to that country’s refusal to respect EU financial rules. As a result, the EUR is likely to remain on the back foot ahead of the EU’s response (due today).

More importantly, the Italy-German yield differential will likely rise further in the EUR-negative manner if the EU takes Italy to task over the budget issue.

The yield differential, however, may drop sharply, lifting the EUR back above the yesterday’s high of 1.1472 if the EU softens its stance.

EUR/USD Technical Levels