EUR/USD's rally from the June 24 low is now at risk, and long-positioned investors may be considering an exit as yield differentials and oil's potential impact on Fed policy create downside risks for the pair.

In early July, the U.S.-German 2-year yield spread

—which EUR/USD typically correlates with—began tightening as U.S. inflation data caused yields to soften, a trend that persisted until last week and helped support EUR/USD's gains. However, the pair's rally stalled just short of resistance in the 1.1500 area, and spreads have since started widening again, increasing the dollar's yield advantage.

Compounding this, a recent sharp rally in oil prices has investors leaning toward the possibility of a more hawkish Fed

stance to combat oil-driven inflation pressures. This combination has pushed the spread back below -140 bps and toward -145 bps, becoming a growing weight on EUR/USD.

Technical factors add further pressure. EUR/USD's rally off the June low only briefly broke above the downtrend line from the May 11 high, and the pair has since fallen back below that line as well as its 10- and 21-day moving averages. The pair is now threatening to break the uptrend line drawn from the June 24 low.

Should that uptrend line break, it would suggest the recent rally was merely corrective within a broader downtrend, raising the possibility that the pair's longer-term decline could resume.
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(Christopher Romano is a Reuters market analyst. The views expressed are his own)