What traders use to predict the euro's next move

The euro rose to a three-month high on Thursday, amid a shift in the global economic picture and a big move in European bond yields.

The recent month-long euro surge comes after a long losing streak. The dominant explanation behind the drop is that the U.S. economy has been seriously outperforming the euro zone economy, and the Federal Reserve is consequently set to raise rates. Both stronger economies and higher rates tend to make currencies more attractive.

But all of the sudden, the U.S. economy appears to be going through a bit of a soft patch. In the the first quarter, the U.S. economy grew at just a 0.2 percent annualized pace (or actually shrank, according to some more recent economist estimates) and economic data since then have been disappointing, such as Wednesday's goose egg of a retail sales-growth number. This has pushed back expectations for when the Fed will raise rates.

"If you go two months back, we were talking about, 'Is the Fed going to go potentially in June?' Now the debate is, 'Will the Fed be able to go at all this year?' So, a huge shift in sentiment," commented Jens Nordvig, global head of fixed income research at Nomura, in a Thursday "Power Lunch" interview.


An image of Euro banknotes being counted. The central bank policies have hit bank profitability in both regions and German banks have been vocal in criticizing Mario Draghi, ECB president, accusing him of punishing savers and undermining their business models.
Leonhard Foeger | Reuters
An image of Euro banknotes being counted. The central bank policies have hit bank profitability in both regions and German banks have been vocal in criticizing Mario Draghi, ECB president, accusing him of punishing savers and undermining their business models.

Meanwhile, the euro zone grew 0.4 percent in the quarter. And German bund yields have surged, perhaps amid "signs that the deflation threat has eased," as Brown Brothers Harriman's global head of currency strategy, Marc Chandler, wrote in a Thursday note.

Technically speaking, deflation is good for those holding a currency, as it increases the value of each currency unit. But in practice, deflation threatens to create an economic morass that makes a currency less attractive in a global context.

Nordvig points to a more direct connection between the direction of bund yields and of the euro—one that speaks to global capital flows.

"One of the reasons why the euro was going down so much over the last 12 months was, there was a steady flow of money coming out of euro zone bonds into U.S. bonds. And now, the markets have become so volatile that the flow is stopping," Nordvig said.

Either way, the direction of German yields may point to further upside for the euro.

"Until bunds stabilize, the euro recovery may persist ... [and] there is no compelling evidence that the high water mark from the German 10-year yield is in place," Chandler wrote.

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