Published: March 22nd, 2023
The Euro to Dollar exchange rate has consolidated over the past six weeks inside a narrow range, but this week’s US Federal Reserve interest rate decision could see a breakout attempt to the up or downside.
Forex traders were selling the single currency widely last week (wc 13th March) amid the fallout from US bank failures and investor worries about the viability of big names in European lending like Credit Suisse. Since then, European banking shares have nosedived, and Credit Suisse has been bought-up by domestic rival UBS.
‘I welcome the decisive action taken by Swiss regulators in the Credit Suisse situation,’ European Central Bank (ECB) President Christine Lagarde said in a statement this week. ‘Their swift action has restored order to markets and sets the stage for a return to financial stability in Europe.’
The quickly-approved merger was followed on Monday by coordinated action between major central banks to inject liquidity into the global financial system and make Greenbacks more available. Analysts say that’s one factor which could improve short-term prospects for the Euro-to-Dollar rate.
‘Under normal conditions these moves would be negative for the Dollar,’ wrote Commerzbank's FX research unit in an analyst note on Tuesday. ‘But the experiences of 2008-2009 have demonstrated that a dearth of USD liquidity outside America can prompt USD appreciation.’
Markets are watching small and medium-sized banks closely for signs of instability, plus some larger institutions. This is because the interest on depositor balances is rising at a time when banking profits are being driven by an excess of low-interest loans granted over the past ten years.
The differential gap between costs and revenues is seen as a serious issue, one that may well have pushed Silicon Valley Bank and others over the brink. Since then, new facilities provided from G10 central banks have helped alleviate some of the systemic risks.
EUR took a beating last week despite financial markets downscaling their expectations for US Fed interest rates ahead of this week’s meeting. That dynamic also weighed on the Dollar, Commerzbank says.
If global markets stabilise this week and next, it could mean EUR would benefit more than other fiats. Much will depend on the Fed’s rate hike decision and any new forecasts it publishes. Forex traders will also be watching for new comment from European Central Bank (ECB) policymakers.
In early January 2023, EUR/USD regained a level not seen since June 2022 after extending a strong recovery. EUR found support from Eurozone energy markets and a retreat by the Greenback driven by economic data. Analysts at one major European bank said they believed further gains were possible.
EUR/USD began the year on the back foot as it retreated from transitional highs against a recovering Greenback, but after a retracement it leapt to a multi-month high on 9th January, as forex traders quickly discounted rumours of an end to the US Federal Reserve's interest rate hiking cycle.
In a note to investors, analysts at ING Bank’s FX analysis unit said the pair ‘has been impacted by a Dollar sell-off and market bias could send it even higher. We are seeing parallels with the summer of 2007 when a slowdown in America’s housing market gave rise to expectations that the Fed would have to take its foot off the gas.’
Reviewing the price action that dominated the pair that year, ING said American two-year bond yields disintegrated to 2.6 per cent after experiencing trade in the 4.5 to 5 per cent range for the first half of the year. By December 2007, EUR/USD had rallied back by 10 per cent.
The Greenback tracked American yields higher last year as global investors looked for better returns, therefore USD would be expected to retreat if this bond market dynamic went into reverse. ING says this is currently what’s happening.
The ECB said in December 2022 that it was ready for two more interest rate rises of 50 basis points, catching investors off-guard as they were gauging whether Frankfurt would slow down.
In June 2022, EUR/USD was trying to climb out of a trough that saw it sink to five-year lows. EUR needed intervention from the European Central Bank (ECB) to beat an already hawkish Dollar market and sustain its recovery momentum ahead of the latest US inflation data print.
The single currency gained substantial support from a hawkish market that re-priced its expectations for ECB interest rate action in advance of the central bank’s late June policy meeting.
The meeting announced the end of Frankfurt’s last and longest running quantitative easing (QE) programme, while providing insights into the future path of European interest rates.
However, forex traders were focused on anything that signaled the ECB’s likely policy direction in July and September, particularly any guidance about the lift Eurozone interest rates could get in July.
In a note to investors, Barclays European Economics Unit said that EUR/USD could rise as the Summer wore on ‘thanks to a more hawkish European Central Bank coming out of Friday’s meeting and a weaker Dollar. In that scenario we believe upside resistance at 1.0789 will be tested.
‘We will be closely monitoring post–meeting communications from the June meeting for indications that the tightening cycle is going to become more aggressive. There is even a small possibility that the ECB decides to raise rates this week.’ EUR started 2022 on sturdy political tailwinds out of Italy, when markets reacted warmly to the appointment of neoliberal technocrat Mario Draghi as Italian Prime Minister.
After President Sergio Mattarella was re-elected in January, analysts thought the election result would establish policy continuity and enable Draghi to move ahead with EU-mandated policy changes required to obtain EUR 200 billion in EU funding.