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 steady against all major currencies. Yesterday, the euro rebounded against the US dollar after making four consecutive lower-lows earlier this week. After the euro moved into oversold territory, we have been calling for a short-term rebound. Today's EUR/USD trading range is 1.130 - 1.1530.
There are no significant fundamental developments related to the euro today. Similar to what we saw yesterday, euro trading is mostly a function of risk sentiment. As currency markets are mostly directionless today, the euro is also unchanged.
Turning to economic data, we'll see final inflation figures for the Eurozone later today. As the numbers are usually in line with the initial estimate, the data is unlikely to have a significant impact on the currency. In other news, Bundesbank Beermann's speech did not address monetary policy. Thanks to slowing growth and peaking inflation, the Eurozone's economy is likely to continue weakening. Our outlook on the euro remains bearish.
|August 14||Germany GDP Growth Rate YoY Flash Q2||2%||2.1%|
|August 14||Germany Harmonised Inflation Rate YoY Final JUL||2.1%||2.1%|
|August 14||Germany Inflation Rate YoY Final JUL||2%||2.1%|
|August 14||Eurozone GDP Growth Rate YoY 2nd Est Q2||2.2%||2.5%|
|August 14||Eurozone Industrial Production YoY JUN||2.5%||2.6%|
|August 14||Eurozone ZEW Economic Sentiment Index AUG||-11.1||-18.7|
|August 14||Germany ZEW Economic Sentiment Index AUG||-13.7||-24.7|
|August 15||Bundesbank Beermann Speech|
|August 16||Germany Wholesale Prices YoY JUL||3.5%||3.4%|
|August 16||Eurozone Balance of Trade JUN||€16.5B|
|August 17||Eurozone Current Account JUN||€4.6B|
|August 17||Eurozone Core Inflation Rate YoY Final JUL||0.9%|
|August 17||Eurozone Inflation Rate YoY Final JUL||2%|
The US dollar is currently steady against all major currencies. Yesterday, the US dollar index (a broad measure of the currency) ended the day slightly lower after making four consecutive higher-highs earlier this week. While the buck was much weaker at the outset of the day, buyers pushed up the currency during New York trading hours. Today's US dollar index trading range remains 95.50 - 97.0.
There are no fundamentals developments driving the dollar today. After most major financial assets entered overbought or oversold conditions earlier this week, currency markets are adjusting accordingly. Looking at the US dollar, there may be an opportunity to go long the currency if the buck falls towards the low-end of its trading range in the near future.
Turning to economic data, initial jobless claims continued decelerating this week. This is a positive development for the US economy, and suggests that the labor market continues to fire on all cylinders. Given the Federal Reserve's mandate to maintain full employment, the health of the labor market is watched closely by the Fed. As all (backwards-looking) economic data points to accelerating growth and inflation, the Fed is more likely to continue raising rates. In turn, this helps the buck. Our outlook on the dollar remains bullish.
|August 14||Export Prices YoY JUL||4.3%||5.3%|
|August 14||Import Prices YoY JUL||4.8%||4.7%|
|August 15||Retail Sales YoY JUL||6.4%||6.1%|
|August 15||Capacity Utilization JUL||78.1%||78.1%|
|August 15||Industrial Production YoY JUL||4.2%||4%|
|August 15||Manufacturing Production YoY JUL||2.8%||2.3%|
|August 15||Business Inventories MoM JUN||0.1%||0.3%|
|August 16||Building Permits JUL||1.311M||1.292M|
|August 16||Housing Starts JUL||1.168M||1.158M|
|August 16||Initial Jobless Claims 11/AUG||212K||214K|
|August 17||Michigan Consumer Sentiment Prel AUG||97.9|
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 take on the euro in late February, we wrote that the bullish case for the currency was looking increasingly challenging. At the time, euro speculators were spooked by slowing forward-looking economic indicators, while upcoming political events in Italy and Germany risked the future unity of the region. While our outlook remains mildly bullish, this comes with the significant cavea…
Improving growth and falling political risk are pushing the Euro higher, but constant changes in the landscape put this movement at risk. Significant declining trends will impact the euro forecast - and speculators and traders should take note of the increased risk.
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…
In our previous take on the US dollar in early February, we wrote that the currency was set to remain weak. At the time, ex-US growth was accelerating, while speculator sentiment was only mildly bearish. While dollar bulls have argued that rate hikes should help the currency, we wrote that expectations for monetary tightening were rising around the world, limiting the impact from the Fed’s action…
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.