06 Feb, 2018 (Updated 07 Feb, 2018)
The EUR/USD exchange rate has been rising – out of sync with interest rate spreads. What gives?
Something curious has been has been happening with the US dollar in recent months. While the EUR/USD exchange rate has climbed higher, the trend is not reflected in interest rate spreads, which should support a stronger dollar.
This disconnect has prompted Nordea Markets FX analyst Andreas Steno Larsen to ask: “Are we in the midst of a regime change that will wreak havoc with the market’s understanding of the most important drivers of EUR/USD?”
Since October or November 2017, EUR/USD has moved from levels around 1.17-1.18 to almost 1.25. At the same time, the gap between USD and EUR interest rates has increased, meaning investors earn more for holding US than, say, German government debt. That rate spread should support a stronger dollar, but the USD has fallen against the EUR and other currencies.
The current market environment is starting to look reminiscent of the period between 2004 and 2007 as the market seems to believe in a regime shift, says Steno Larsen.
“Back then, the USD weakened when risk appetite was solid and was bought when risk appetite deteriorated. This is now widely back in the markets,” he adds.
One possible explanation could be the synchronized global recovery. As the world’s economic and political wounds now seem to have healed, it makes increasing sense to reallocate away from the already-strong USD. What’s more, the US Federal Reserve is the central bank furthest along in the normalisation process and rate hiking cycle, leaving more room for other central banks to catch up – and more gains to be made on other currencies.
So what does all of this mean for the EUR/USD going forward?
We recently updated our forecast. While we expect the recent EUR/USD momentum to pause in the short term, we see more upside longer out. Read the full analysis.
And watch this webinar, recorded on 7 February, with Andreas Steno Larsen when he dives into the technicalities at play.