Arguably one of the trades of this year (besides buying gold and silver) was longing EURUSD. The major forex pair rose from below 1.07 to a staggering 1.1780 yesterday – more than a thousand pips in three months.
The EURUSD posted seven consecutive daily higher highs in a row yesterday. Judging by how inflation leads the EURUSD exchange rate, the pair seems poised to break above 1.20 – a level considered impossible to reach at the start of the health crisis. After all, the USD is the safe-haven currency and not the Euro.
So, what happened? And where will the Euro stop surging?
What Pushes the EURUSD Exchange Rate Higher?
To start with, it is the European framework for common fiscal policy. The Next Generation EU fund and the plan to issue common debt and redistribute the proceeds among EU members as grants and loans looks like the start of a common EU fiscal agenda. Financial markets loved it, and the Euro surged.
On the other side of the Atlantic, the Federal Reserve (Fed) message has been clear – no interest rate hikes in sight anytime soon. The Fed balance sheet, after shrinking for a couple of years under Janet Yellen’s watch, began expanding aggressively again when the coronavirus crisis started.
What is more frightening is that in order to fill the policy gap, if no other tools are used, the balance sheet holdings are projected to go parabolic. Hence, a lower USD is another answer to a higher EURUSD exchange rate.
On top of that, the net USD positioning, especially by asset managers, is very bearish. Everyone and their mothers in the financial world appear to sell the USD – non-commercial traders, asset managers, leveraged funds.
However, why would the funds out of the USD pour into the Euro and not some other currency? To some extent, the Australian and New Zealand dollars also gained ground against the American dollar, but the rise was not so steady as in the case of the Euro.
One possible explanation is that Europe is seen as better-handling the coronavirus than the United States. For this reason, investors trust the Euro to better protect their investments than the USD.
Another is that the European equity markets lag the U.S. stock market by a mile. To gain exposure in Europe, one must own the local currency before investing in the European stock market.
All these, and some more, contributed to the steady rise in the EURUSD exchange rate. The Fed tomorrow is viewed as key for future developments in the EURUSD.