intro – eur usd:
EUR USD or Euro USDollar is the most popular currency pair by traded volume in the world. Inspite of the fact that the EUR-USD pair has been around for only 20 years(at the time of writing this in 2020), it is the most efficient fx market in the world, due to high volume of trade between US and Euro trading bloc.
To begin with, we will take a look at how EUR USD came into existence. We will then look at the most important variables and factors that influence EUR USD. Finally, we will investigate how central bank policies and actions in US and Eurozone influence EUR USD movement.
a detour back in time
The global fx markets in the latter decades of last century were very different than today(2020). For instance, the GermanDeutschmark-USDollar was one of the big pairs, along with the FrenchFranc-USDollar.
On 1 January 1999, the Euro came into existence. The journey leading to the euro began decades before. However, none of the previous attempts saw the light of day. This was primarily due to lack of digitalisation of transactions and economic data reporting. In addition to other concerns around mass adoption of EUR such as potential of high inflation in some member states, decentralised monetary policy etc.
The original EUR USD exchange rate on 01-Jan, 1999 was 1.1686. This was based on a previous project called ECU. ECU stood for European Currency Unit. In a nutshell, it was a basket of key European currencies, designed to aid stability in European exchange rates.
Euro became a real world cash based currency in 2002. Prior to this, the EUR was tied to the ratio of the constituent Eurozone currencies in the ECU basket. This ratio played a part in determining the exchange rate of EUR USD. For instance, German Deutschmark, the French Franc, the Spanish Peseta, the Italian Lira, etc. were the constituents.
back to today
According to Office of the US trade representative website, U.S. goods and services trade with the EU totalled nearly USD1.3 trillion in 2018. Exports totalled USD575 billion; Imports totalled USD684 billion. Furthermore, the U.S. goods and services trade deficit with the EU was USD109 billion in 2018.
In Summary, this leads to a significant amount of EUR and USD exchanging hands between individuals, corporations and governments. Therefore, this makes EUR USD the most liquid and also the most efficient fx currency market in the world.
variables and factors that impact EUR USD market
trade volume
Firstly, the trade volume between Eurozone and US dictates the demand for EUR or USD respectively. For instance, if Americans suddenly start buying a lot of German cars, this will cause a spike in demand for Euros, since the German car manufacturers will have to be paid in Euros. On the other hand, if German car manufacturers suddenly start investing in YouTube video ads to increase their car sales, then this will lead to a spike in demand for USD, since Google(YouTube’s parent company) would want to be paid in USD.
inflation
Secondly, domestic inflation in EuroZone and US also impacts the EUR USD rate. Higher inflation depreciates the value of the currency. For instance a higher inflation rate in Eurozone, means that generally a car part ‘X’ that was EUR 10, now costs lets say, EUR 11. As a result, German cars could now become more expensive for American consumers, leading to a potential fall in demand for German Cars. As a result, German car manufacturers, will keep the prices consistent in USD. Hence, the markets will see a depreciation in the value of EUR vs USD. Consequently, the German Manufacturer will get paid more EUR per USD. However, their EUR will be worth less now due to positive inflation. This is assuming 0 inflation rate change in US and all other factors being static.
interest rates
Thirdly, short and medium term interest rates will impact the EUR USD market as higher rates in any currency will increase the demand for that currency. As a result, the domestic currency’s value will appreciate. For instance, if the rates in US go up, the German Car Manufacturer who got paid in USD might park the USD cash reserve in an interest paying account or buy US Govt. bonds, instead of exchanging it into EUR.
and the rest
Finally, other factors such as unemployment rate and PMI(Purchasing Managers Index) also impact the value of EUR USD. Unemployment rate(in addition to per Capita GDP) is a measure of how much disposable income the consumers have, that they can spend on foreign goods . For instance, lower unemployment and higher per Capita GDP in US will increase demand for all cars(including German cars), and so, a higher demand for EUR. Meanwhile, a higher PMI in US will mean an increase in economic activity in US leading to higher employment and a high demand for USD to pay those employees.
impact of Monetary Policies
The FED has a dual mandate:
- To stimulate maximum employment
- To stabilise prices(control inflation)
In contrast, the ECB’s primary objective is price stability.
Disparity in policy can lead to interesting effects on the EUR USD rates. For instance during a financial crisis, Fed’s first priority will be to avoid mass unemployment. Hence support measures such as bond buy back will be introduced to increase money supply, thereby depreciating the USDollar. On the other hand, ECB(European Central Bank) would want to avoid high inflation, and therefore will be cautious about increasing money supply.
final comments
It is important to spend some time learning the history and basics. This time spent will yield dividends when you are trying to predict movement of an asset. Also remember that you are more rational before you place a trade. So, it’s important to set some rules. If you like market conditions and they fit what your rules suggest, go for it. If the conditions for the rules don’t fit what you see in the markets, don’t trade for it’s own sake. You don’t have to trade every day. The point of having rules is to run them to your favour, and not let them run you.
Day trading follows the same rules we use for life. Successful trading is the art of using knowledge and skills at the right time. It is also essential to set some limits once you open a position. For example, you may impose a limit on yourself to not keep a trade open for more than 20 days. Finally get access to good tools that can help you achieve your trading goals. It’s best to try out a lot of things on paper money accounts before risking your capital.
Despite of all the rules, limits and right mindset, random events will happen. So always have a contingency plan. A perfect system or rules don’t exist. And, this is a good thing. Otherwise, someone will work it out and own half of the free world. All algorithms, tools, systems and rules are based on a snapshot of data. So always pay attention to news and data on a given day.
how to apply this to trading
STOKAI provides daily EUR USD prediction using algorithms based on all factors that impact the price of EUR USD. Then, it evolves this over 10 days in the future. Tutorial and brief user guide is available here – Tutorial
Stokai is a product of Rumble Horse Tech ltd. A company registered in England.