The story through the first half of the year was “sell the dollar”. The greenback lost over 10% of its value in less than six months, one of the steepest declines of the new century. The main beneficiary of those losses was, counterintuitively, the Euro. The shared currency rose even faster against the greenback, despite the ECB cutting rates while the Fed held fast.
Now, the situation seems to be reversing. The Fed has shifted into cutting mode while the ECB is happy to keep policy unchanged. Normally, lower rates weakens a currency. But, instead, the counterintuitive trend of earlier in the year might kick back in. That would imply that the EURUSD could potentially trend lower through the rest of the year.
In a Good Place Vs Economic Challenges
On Thursday, the ECB appeared to be as content as a central bank can be. It’s President, Chistine Lagarde reiterated a line she’s been using since the prior meeting, saying that inflation is in a good place. As if to reaffirm her comments, flash Eurozone CPI for October was reported on Friday at 2.1%, down from 2.2% and in line with expectations. That’s just one decimal off from the ECB’s 2.0% target.
A day earlier, the FOMC decided to cut rates as was anticipated. There was a bit of a twist, since Fed Chair Jerome Powell cast doubt on a third rate cut for this year that was widely expected to happen in December. The immediate response was a slightly stronger dollar, but that faded fairly quickly as traders began to worry that higher rates would slow the US economy.
Breaking the EURUSD Trend
The end result of the rate decisions from the two largest central banks in the world is a slightly stronger dollar. Although, the EURUSD is down for the week, it should be noted that the Euro overall is higher against other currencies.
But looking at a longer time frame, the EURUSD has been pretty much flat since exactly the start of the second half. After rocketing up 12% in a matter of three months, the currency pair has been pretty stable. The question is whether the downturn of this week can be added to a downtrend for October that means the currency pair will break below the range it has been in for the last four months.
Shifting Investor Incentives
The rapid rise in the Euro came in the wake of US Presidend Donald Trump announcing a major hike in tariffs. This led to worries that the US economy would underperform. By contrast, Europe was ramping up government spending, and appeared to offer better returns on investment.
However, since the start of the second half, funds have turned around and Q3 saw a net positive flow in assets to the US from Europe. That indicates that markets are moving more on the basis of the economic growth outlook, rather than the usual interest rates. In that case, cutting rates might actually boost the currency as lower rates incentivize economic growth. In other words, monetary policy might have the opposite impact on currencies. However, this is still contingent upon whether the economy continues to show signs of recovery. Which means the EURUSD might react more to indicators of economic health (such as PMIs and GDP numbers) than inflation.
