EUR/USD, or euro to US dollar, is the world's most actively traded and watched currency pair. This is because the United States and the Eurozone collectively make up 40% of global GDP. The pair tends to rise during global economic booms while selling off sharply during downturns. As an example, the pair sold off sharply during the 2008 global financial crisis and during the 2010-2011 Eurozone debt crisis. In recent times, EUR/USD has enjoyed tailwinds from political stability in the European Union, strong global growth and weakness in the US dollar. Those looking to make euro to dollar conversions should take the current economic backdrop into account.
The euro is currently strengthening against all major currencies. Last week, the euro ended the week slightly lower against the US dollar. Note that trading volumes in euro futures decelerated week-over-week for the fourth week in a row. Light volumes suggest that traders have been selling the euro with less conviction in recent history. Today's EUR/USD trading range is 1.1450 - 1.1820.
Following the European Commission's rejection of Italy's government budget, traders remain focused on the issue. Over the weekend, Moody's downgraded Italy's government credit rating to one notch above junk grade. However, the ratings agency upgraded the outlook on Italian government bonds to stable (suggesting no further ratings downgrades are likely in the short-term). Looking at reactions in financial markets, 10-year Italian government bond (BTP) yields are falling today while comparable 10-year German bond (bund) yields are rising. In the short-term, this suggests that traders are buying BTPs while selling bunds. In other words, traders are increasingly optimistic with regards to Italian risks. As risk sentiment improves, the euro also appears to be benefiting as a result. As a 'risk on' currency, the euro tends to strengthen in response to improving risk sentiment.
Looking at this week's economic calendar, traders will be focused on a number of items such as Markit PMIs, the IFO sentiment survey and the ECB's upcoming interest rate decision. While both actual growth and forward-looking indicators (such as sentiment surveys) point to an ongoing slowdown in Eurozone growth, the European Central Bank remains upbeat on the region's economic prospects. More specifically, the Bank continues to signal an end to its quantitative easing program (buying government bonds using the ECB's balance sheet). While tightening monetary policy is typically positive for the euro, this is not necessarily the case when Eurozone growth is slowing. Under today's circumstances, the ECB risks exacerbating the slowdown by ending its quantitative easing program too late in the economic cycle. Our outlook on the euro remains bearish.
EUR/USD is up and trading above 1.1530. The euro is up against the yen, with EUR/JPY trading above 130.0. Finally, the euro is flat against the pound, with EUR/GBP above 0.880.
|October 19||Eurozone Current Account AUG||€20.5B||€30B|
|October 22||Bundesbank Monthly Report|
|October 23||Germany PPI YoY SEP||3.1%|
|October 23||Eurozone Consumer Confidence Flash OCT||-2.9|
|October 24||Germany Markit Composite PMI Flash OCT||55|
|October 24||Germany Markit Manufacturing PMI Flash OCT||53.7|
|October 24||Germany Markit Services PMI Flash OCT||55.9|
|October 24||Eurozone Markit Composite PMI Flash OCT||54.1|
|October 24||Eurozone Markit Manufacturing PMI Flash OCT||53.2|
|October 24||Eurozone Markit Services PMI Flash OCT||54.7|
|October 24||Eurozone Loan Growth YoY SEP||3.1%|
|October 24||Eurozone M3 Money Supply YoY SEP||3.5%|
|October 25||Germany GfK Consumer Confidence NOV||10.6|
|October 25||Germany Ifo Business Climate OCT||103.7|
|October 25||Germany Ifo Expectations OCT||101|
|October 25||Germany Ifo Current Conditions OCT||106.4|
|October 25||ECB Deposit Facility Rate||-0.4%|
|October 25||ECB Interest Rate Decision||0%|
|October 25||ECB Marginal Lending Rate|
|October 25||ECB Press Conference|
|October 26||ECB President Draghi Speech|
|October 26||ECB Cœuré Speech|
The US dollar is currently steady against all major currencies. Last week, the US dollar index (a measure of the currency against its largest peers) ended the week slightly higher. Week-over-week trading volumes in US dollar index futures were slightly lower relative to the previous week, suggesting weakening conviction behind the move. Today's US dollar index trading range is 94.30 - 96.50.
While the dollar remains in a bullish trend, the currency has struggled to rise above its previous highs seen in mid-August. As described in a recent commentary, strong US economic data in the third quarter (such as August retail sales and industrial production growth) have kept the dollar in check. As US economic data now deteriorates in rate-of-change terms, changing economic conditions suggest that the dollar is likely to strengthen further. As a safe haven currency, the US dollar tends to strengthen the most when global growth is slowing.
Looking at recent economic events, Dallas Federal Reserve President Kaplan said that two to three more rate hikes were necessary to bring monetary policy to a 'neutral' stance last Friday. Most members of the Federal Reserve agree that current economic conditions warrant further rate hikes. Historically, the Fed has raised rates when economic growth and inflation are already slowing in rate-of-change terms (thereby exacerbating a slowdown). Assuming the Fed continues to signal further rate hikes, the combination of monetary tightening and deteriorating growth is likely to send the dollar higher.
Looking at this week's economic calendar, traders will be focusing on upcoming Markit PMIs, durable goods orders, wholesale inventories, and the first estimate of Q3 GDP growth. As alluded to above, forward-looking indicators such as PMIs (sentiment) are likely to continue deteriorating. While US GDP growth held up well in the third quarter, the figures are unlikely to have a significant impact on financial assets as they are backwards-looking by nature. Our outlook on the dollar remains bullish.
|October 19||Fed Kaplan Speech|
|October 19||Existing Home Sales SEP||5.15M||5.33M|
|October 19||Fed Bostic Speech|
|October 22||Chicago Fed National Activity Index SEP||0.18|
|October 23||Fed Kashkari Speech|
|October 23||Fed Bostic Speech|
|October 24||Fed Evans Speech|
|October 24||Markit Composite PMI Flash OCT||53.9|
|October 24||Markit Manufacturing PMI Flash OCT||55.6|
|October 24||Markit Services PMI Flash OCT||53.5|
|October 24||New Home Sales SEP||0.629M|
|October 24||Fed Bullard Speech|
|October 24||Fed Mester Speech|
|October 24||Fed Bostic Speech|
|October 25||Goods Trade Balance Adv SEP||$-75.8B|
|October 25||Durable Goods Orders MoM SEP||4.5%|
|October 25||Durable Goods Orders Ex Transp MoM SEP||0.1%|
|October 25||Initial Jobless Claims 20/OCT||210K|
|October 25||Wholesale Inventories MoM Adv SEP||1%|
|October 25||Pending Home Sales YoY SEP||-2.3%|
|October 25||Kansas Fed Manufacturing Index OCT||10|
|October 26||Fed Mester Speech|
|October 26||GDP Growth Rate QoQ Adv Q3||4.2%|
|October 26||PCE Prices QoQ Adv Q3||2%|
|October 26||Core PCE Prices QoQ Adv Q3||2.1%|
|October 26||Michigan Consumer Sentiment Final OCT||100.1|
In our last commentary on the euro in late August, we wrote that the common currency was set to weaken further thanks to (1) slowing growth, (2) slowing inflation and (3) an outsized speculator long position in euro futures and options. Following the publication of our last commentary, EUR/USD has weakened from 1.1730 – 1.180 (the top-end of its trading range that we update daily on our...
In our last take on the euro in April, we wrote that the bullish case for the currency was running out of drivers. Specifically, we wrote that decelerating Eurozone growth (in rate-of-change terms), changes in trading patterns and overly bullish speculator sentiment was likely to weigh on the euro in the future. At the time, EUR/USD was trading around 1.23, near its 2018 high just above 1.2550.
Earlier today, we downgraded our euro outlook to neutral in the medium-term, and bearish in the short-term. As the euro runs out of momentum, the trend is now neutral based on quantitative factors such as price, trading volumes and volatility. While forward-looking economic indicators continue to suggest an ongoing expansion, growth appears to be slowing in rate-of-change terms. This is why our p…
In our previous commentary on the US dollar, we wrote that the buck was set to rise further thanks to our forecast for slowing US growth and inflation. Given the US dollar’s safe haven qualities, the currency performs the best when economic conditions deteriorate. Following the publication of our last commentary, the performance of the US dollar index (a measure of the currency against major pee…
In our last commentary on the US dollar, we wrote that the buck was set to move higher given underlying economic trends. Specifically, US growth and inflation was likely to keep accelerating, while the opposite was likely to happen in most major regions outside the United States. Following the publication of our last commentary, the US dollar index has strengthened from around 91.80 to around...
In our previous commentary on the US dollar, we warned that a weak dollar was hiding significant risks in growth-sensitive assets such as equities and European currencies. As the world’s reserve currency, the buck is inversely correlated to most financial assets because most cross-border lending is conducted in dollars. Thanks to a slowdown in economic growth outside the United States coupled wit…
Significance of the EUR/USD pair
The euro to US dollar exchange rate is the world’s most traded currency pair. This is because the Eurozone and the US are the world’s two largest economic regions looking at GDP in current US dollars. Based on data from the World Bank, the Eurozone’s GDP in 2016 was $11.9T while US GDP for the same year was $18.6T. Together, the Eurozone and the US represent more than 40% of the world’s total economic output. Unsurprisingly, EUR/USD is watched closely by traders around the world. A visual overview of GDP growth for the US and Europe in recent history is shown below:
Early days of EUR/USD
When the euro was first launched in 1999, it existed only as a digital currency. EUR/USD began trading at an initial value of 1.1696 and almost immediately started depreciating. The currency pair hit its all-time low of 0.8230 in October 2000. The initial weakness of the euro against the US dollar was blamed on many factors including weak economic growth, low risk appetite and low productivity in the Eurozone. With the benefit of hindsight, risks relating to the survival of the common currency was probably the main reason for the sell-off. Given that the Eurozone is not a unified political entity, there were doubts regarding the euro’s staying power. Many famous economists including Milton Friedman predicted the ultimate demise of the euro.
After Eurozone members introduced physical banknotes and coins in 2002 (and required all new commerce to be conducted in the common currency), the euro began strengthening against the US dollar. Between 2002 and 2008, EUR/USD enjoyed a bull market and strengthened to its all-time peak of 1.6038 in July 2008. During this time, the Eurozone enjoyed strong GDP growth and rising stock markets. Unfortunately, the advent of the 2007-2008 financial crisis in 2007 led to the euro plunging in value.
EUR/USD during the 2007-2008 global financial crisis
Initially, the 2007-2008 financial crisis began as a crisis involving the US real estate market. Prior to the crisis, borrowers lacking in creditworthiness were able to acquire large mortgages. Eventually these borrowers fell behind on their mortgages, and investors in US mortgages faced record losses. As the crisis worsened, the global nature of the problem was revealed and the euro subsequently plunged in value.
Prior to the crisis, European banks borrowed US dollars offshore while making loans in other currencies. Instead of relying on retail bank deposits, European banks simply borrowed money from wholesale markets (where US dollars were available very cheaply). This process has been more deeply described in a report on the US dollar shortage during the crisis authored by the Bank for International Settlements.
During the crisis, the offshore US dollar market began freezing up, and banks were no longer able to cheaply borrow US dollars. At the same time, loan default rates began spiking as the crisis worsened. Soon, it became clear that the Eurozone’s banks desperately needed US dollars to prevent the crisis from escalating. Without access to US dollars, banks were forced to dispose their loans at fire sale prices, thereby exacerbating the crisis. While the US Federal Reserve initially resisted bailing out non-US institutions, it ultimately provided a US dollar credit line to the ECB on December 12, 2007. Despite the credit line, the euro plunged in value as markets feared for the worst. The exchange rate made a long-term bottom below 1.26 in October 2008.
EUR/USD following the global financial crisis
Following the crisis, EUR/USD began rallying after the first quarter of 2009. The exchange rate then peaked in November of the same year around 1.50. By late 2009, reports that the Greek government had concealed the country’s true indebtedness began appearing in the media. As French and German banks owned a significant portion of Greek government bonds, fears began spreading of a government debt default followed by a Eurozone banking crisis. Significant debt subsequently became an issue in other countries including Ireland, Portugal, Italy and Spain. The EUR/USD exchange rate once again began falling. It bottomed in May 2010 below 1.19.
Rescue funds and bailouts
In response to the growing Eurozone debt crisis, the European Central Bank began creating various bailout funds that would buy government debt in order to prevent the panic from accelerating. These include the European Financial Stability Facility (EFSF) and the European Financial Stabilization Mechanism (EFSM).
The actions of the ECB ultimately brought confidence to the Eurozone’s banking system. This helped spark another EUR/USD bull market. The pair peaked in May 2011 above 1.47.
2011/2012 bear market and LTROs
In the second quarter of 2011, the outlook for the Eurozone once again began weakening. Following bitter negotiations between creditors (principally Germany) and debtors (Greece and Italy), markets began doubting the Eurozone’s resolve in solving the crisis once and for all. Economic growth was also slowing at this time, further exacerbating the debt crisis. During this time, the ECB launched its LTRO (long-term refinancing operation) program, providing low interest rate loans to Eurozone banks.
While the formation of bailout funds quelled concerns in the past, fears were growing that Germany would no longer tolerate underwriting any further bailouts. Global stock markets also experienced significant weakness during this time. France’s CAC40 fell by 20% in two weeks after markets feared that the country would lose its AAA bond rating. Looking at EUR/USD, the exchange rate weakened below 1.21 by July 2012.
‘Whatever it takes’
In 2012, Mario Draghi (the ECB’s governor) had decided that enough was enough. At a conference in London he famously declared that the ECB will do “whatever it takes” in order to save the euro. He also added: “we think the euro is irreversible”. The message was that the ECB was willing to consider deeply unorthodox means in order to ensure the continuity of the common currency. Shortly after his speech, the ECB introduced a new program called Outright Monetary Transactions (OMT). Under OMT, the ECB would consider buying the bonds of any Eurozone government up to an unlimited quantity. The announcement of the program was highly effective, and Eurozone government bonds rallied as a result. Looking at EUR/USD, the exchange rate rallied to just under 1.40 by May 2014.
The great fall of the euro
Following Draghi’s “whatever it takes” speech, it became clear that the ECB was moving into a new era of unorthodox monetary policy. By May 2014, the ECB began pursuing negative interest rates and quantitative easing (buying government and corporate bonds using the Bank’s balance sheet). As the US Federal Reserve was tapering its third quantitative easing program at the time, the implications for EUR/USD were fairly clear. Despite Germany’s insistence on a strong currency, the ECB moved to substantially weaken the euro.
Once Draghi launched his monetary policy ‘bazooka’, the euro began a steep sell-off. From its peak around 1.40 in May 2012, the exchange rate bottomed below 1.05 by March 2015.
2015 to present
The extraordinary actions of the ECB drove down the value of the euro, while sparking an economic and export boom. While the currency faced an existential crisis between the 2007-2008 global financial crisis and 2014, fears surrounding the currency’s collapse slowly dissipated. Even the Eurozone’s weakest members, such as Greece and Italy, staged an economic turnaround during this time. In an earlier commentary, we wrote that Italy’s turnaround in 2017 has been remarkable. Despite fears that the country would elect a ‘Euroskeptic’ government, Italian politics continues to be dominated by incumbents. This is partly thanks to good economic growth.
Given the ECB’s monetary policies during this period, few were willing to hold onto the euro as other currencies offered relatively higher rates of interest. Unlike the ECB, the Federal Reserve was raising interest rates during this period. Between 2015 and 2016, EUR/USD traded in a range between 1.05 and 1.15.
The 2017 Macron rally
Fears of a Eurozone breakup once again led to weakness in the common currency prior to the French elections. This time, the popularity of Marine Le Pen in the polls threatened the unity of the economic region. Given her calls to leave the euro and have a national referendum on continued EU membership, investors sold their euro as a result. Fears of a ‘Frexit’ were finally put to rest following the victory of Emmanuel Macron in the French presidential elections.
As political risks once again subsided, traders began betting on policy normalization. As we wrote ahead of the October 2017 ECB meeting, buying euros was a consensus trade in late 2017 that few were able to resist. Despite the high risk associated with the trade (as large, one-sided speculator positions are at a higher risk of a big reversal), euro traders bought up the currency in large quantities.
From its lows below 1.06, EUR/USD reached it latest peak above 1.20 in early September 2017. As economic growth from the Eurozone has continued to positively surprise markets, the medium-term rally continued into late 2017. During this time, accelerating growth drove euro trading as political risks continued to fade.