Talking Points:
- ECB vs. Fed monetary policy outlook points to EUR/USD weakness
- Onset of QE, negative rates have made Euro into anti-risk currency
- Fundamentals likely to weigh on EUR/USD after risk aversion fades
A deep divergence in Federal Rserve and ECB monetary policy might have been expected to drive EUR/USD lower. The US central bank has long since ended its QE effort and even began to raise the benchmark interest rate in December. By contrast, the ECB has delivered €60 billion/month in QE since early 2015 and has hinted at an expanded easing effort ot be unvailed in March.
Despite such seemingly damning fundamentals, the Euro has trended higher since December 2015. The move has tracked the slump in stock prices, making for a strong inverse correlation between EUR/USD and the benchmark S&P 500 stock index. This relationship reflects the impact of the very easing that ought to have hurt the single currency: ultra-cheap Euro borrowing costs have made the common unit a carry trade funding currency, meaning that periods of risk aversion trigger gains as traders unwind yield-seeking short-EUR positions.
Looking ahead, policy-derived fundamentals ought to return to the forefront as risk aversion fizzles. This is likely to bode doubly ill for the Euro, as downward pressure courtesy of a dovish ECB posture compared to that of the Fed is compounded by the return of carry-inspired selling.
--- Created by Ilya Spivak, Currency Strategist for DailyFX.com
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