In our article today, we’ve decided to have a closer look at the main factors that influence the behavior of one of the most commonly traded pairs – EUR/USD. Given that an extremely large portion of overall FX trading volume is made on this pair, those can be quite important to know.
There are 19 countries that employ the Euro in their GDP calculations: Germany, France, Cyprus, Estonia, Italy, Spain, Latvia, Lithuania, Malta, Slovakia, the Netherlands, Slovenia, Belgium, Austria, Finland, Portugal, Ireland, Luxembourg and Greece.
The European Central Bank (ECB):
This is the financial authority of the Eurozone. The governing body of the ECB is its Governing Council, which consists of the Executive Board, and governors of national central banks. The Executive Board consists of the President of the ECB, Vice President, and 4 other members.
The goals of ECB policies:
The main purpose of the ECB is price price stability. Here are the two main components of financial policies. The first is the future of financial events, and risk management related to price stability. Price stability is determined by the growth of the Harmonized Index of Consumer Prices (HICP) by no more than 2 %. While HICP is very important, many indicators and forecasts are also employed for determining midterm threats to price stability. The second component is the monetary growth, formulated as marginal profit. ECB recommends a yearly growth of 4.5% for marginal profits.
The ECB council convenes on every second Thursday of each month, in order to announce its interest rates. With every first meeting during the month the ECB holds a press conference where they provide information regarding monetary policies and the economy in general.
The discount rate of ECB is the key short term interest rate of banks, used to control liquidity. The difference between the discount rates of ECB and the Federal Reserve in USA – is a good indicator for EUR/USD.
3 month Euribor:
The interest swap rate for a 3month Euribor, i.e. a deposit made in banks outside of the Eurozone. This indicator serves as a valuable reference for difference between interest rates, and helps to evaluate the exchange rates. As a theoretical example for the EUR/USD pair, a high difference between interest rates, in favor of euribor, against a euro-dollar deposit – indicates a high probability of EUR/USD growth. Sometimes though, this proportion doesn’t work out due to influence of other factors.
The 10 year Bund:
Another important factor for EUR/USD is the difference of interest rates between the US and the Eurozone. Typical references for this are the German 10 year Bund obligations. Given that the interest rate for 10 year Bund is lower than US 10 year bonds, the tightening of spreads (i.e. decrease of US bonds volume or and increase in the volume of German bonds) is an indication of potential EUR/USD growth. The widening of this spread, on the contrary, acts against the EUR/USD
The most important financial news comes from Germany, the powerhouse of the European economy. They key data are: GDP, inflation (CPI and HICP), Industrial production, unemployment. In particular, for Germany some of the key data is contained in IFO reviews, which is a commonly used index of business activity. Another important indicator is the budget deficit of other countries, which, according to the Agreement about Growth and Stability, has to be maintained on a level of no more than 3% of GDP. Any countries that are challenged by budget deficit issues have a negative influence on Euro price rates.
Sometimes the EUR/USD is influenced by fluctuations of non-Dollar cross pairs, such as the EUR/JPY or EUR/CHF. For example, EURUSD could have been falling on the backdrop of highly positive financial news form Japan, which is filtered through the decline of EUR/JPY.
There is a very high negative correlation between EUR/USD and USD/CHF, which reflects the similarity between the Euro and the Swiss Frank. This happens because the Swiss economy is highly dependent on the economy of the Eurozone. In most cases, a downtrend on the EUR/USD is accompanied by a downtrend on the EUR/CHF.
Just as any other exchange rate, the EUR/USD is receptive to political instability. Political instability in neighboring countries, such as Russia for example, is also a red flag for the EUR/USD, due to the considerable amount of German investment in Russia.