The Euro-Dollar Relationship is in the Hands of the ECB

The Euro-Dollar Relationship is in the Hands of the ECB
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2017 started out as a bullish year for the U.S. dollar as it hit the highest level since 2002 in early January. The dollar index traded to 103.815 in the first days of trading last year. What started as a correction from the high, turned into a bear market in the greenback.

The rally in the dollar index started back in May 2014 when it found a bottom at 78.93 and over a ten-month period it made its way 100.

Source: Barchart

 

As the weekly chart highlights, the U.S. currency rallied by over twenty-seven percent which is a significant move over such a short period. Around 60 percent of the dollar index depends on the relationship between the dollar and euro currencies. In late December 2016, the euro looked like it was heading for parity against the dollar as it fell to a low of $1.03675.

The full scope of the move in the dollar index took it from 78.93 in May 2014 to 103.815 in January 2017, a move of over 31.5 percent. 

 

Source: Barchart

 

Over the same time horizon, the euro-dollar relationship moved from $1.39930 in May 2014 to the December 2016 bottom, a move of over 36 percent to the downside.

The primary determinate of the path of foreign exchange relationships is the interest rate differentials. In 2014, the U.S. central bank began tapering its quantitative easing program, and in December 2015, liftoff from a zero percent Fed Funds rate caused the dollar to appreciate. Perception of the future course of monetary policy by central banks drives currency differentials.

Since the Fed began to tighten credit, their future intentions are transparent, and now all eyes have shifted to the European Central Bank. In Europe, short-term rates remain at negative forty basis points and QE remains in place at the start of 2018. However, global economic growth has caused conditions in Europe to improve over recent months, and it will not be long before the ECB’s QE program ends and the central bank tightens credit. The ECB followed the Fed into an extended period of accommodation and now they follow the U.S. central bank out.

With the dollar index sitting close to recent lows at critical support at 90.99, a more hawkish ECB could trigger a move to the downside in the index during 2018. The dollar moved a total of 31.5 percent during the shift in monetary policy and the same movement in the euro currency could take it back to the $1.36 level against the dollar. The exchange rate was trading at around $1.21, so there is another twelve percent room on the upside if a similar move were to occur this year. It continues to look like we are in for more volatility in the dollar-euro currency relationship in 2018.

 

 

 

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