Until recently, the single European currency was under pressure due to divergence in the monetary rates of the Federal Reserve and the European Central Bank. The euro also suffered from interruptions in the supply of components to the EU from China and weak macroeconomic indicators of almost all major European countries and the eurozone as a whole. However, in the past seven trading days, the fall of EUR/USD has given way to rapid growth. If the main currency pair was trading at 1.0780 on February 20, now it is above the 1.11 mark.
It should be noted that something similar already took place during the 2008 global economic crisis. Amid a sharp decline in stock indices, at a certain moment gold that was growing earlier began to fall in price. This happened because some market participants began to sell precious metals in order to plug holes and maintain unprofitable positions formed on stocks.
The question is, where should the investor go in conditions when the USD index is also falling, and high-yield and risky assets are falling by definition? All that remains is the euro, which temporarily acquires the status of a defensive asset that helps to survive the collapse in the stock market. However, if only the stock exchanges stabilize, they will start selling the euro from the top with terrible force. It is possible that this moment is already close.
Shares receive investor support pending coordinated action by national governments and central banks.
In particular, investors are actively playing out the idea of a deeper interest rate cut by the Fed compared to the ECB. Rumors about the weakening of the monetary policy of the Fed at an extraordinary meeting add fuel to the fire. Goldman Sachs and BofA Merrill Lynch experts expect that after the FOMC meeting in March, borrowing costs will fall not by 25, but by 50 basis points.
It is possible that money markets have already laid very ambitious expectations in quotes. This revaluation last week became one of the main drivers of volatility.
Apparently, the markets have gone too far in their fears, which again creates favorable conditions for the dollar to grow as part of a rebound in the near future.
Against the backdrop of more than a weekly correction of the markets, the USD index slipped 2%, returning closer to the middle of the trading range over the past year after reaching three-year highs on February 20. The transition from the dollar to less profitable currencies occurred along with a sharp revision of expectations regarding the monetary policy of the Fed.
Currently, federal funds rate futures indicate a 100% chance of a 50-point decline in March. As of February 20, the derivatives market gave almost equal chances of keeping rates at the current level (1.50% –1.75%) and one decrease (1.25% –1.50%).
However, the full effect of lowering interest rates in the economy becomes noticeable only after six to nine months. In this regard, sharp cuts in rates are likely only with forecasts of a prolonged and sharp slowdown in economic activity. Now, however, most experts are inclined to believe that the effect will be short-term.
Most likely, measures to support markets will now focus on a short-term infusion of liquidity, and lowering rates against this background will be less decisive.
There is another point. The coronavirus epidemic is so far more affecting Europe than the United States. This is due to both the number of cases in the EU and its close ties with manufacturing companies in China. In this regard, the ECB's more stimulating actions look more logical than the Fed. This could be a turning point for the forex market. Last week, traders put too aggressively into the quotes expectations of lower interest rates by the US central bank.
It is possible that in the coming days, such a reassessment of expectations will put pressure on the long-term interest rates on eurozone government bonds. One can hear assurances that the Fed is unlikely to meet recent expectations. This means that the pendulum of the foreign exchange market has high chances to swing again towards a stronger dollar and increased pressure on the euro.
The material has been provided by InstaForex Company - www.instaforex.com