Exchange Rate Behavior

Exchange Rate Behavior

Over the most recent five years, the EUR/USD exchange rate has seen a few essential and middle patterns driven by a scope of economic, regulatory, and political variables in both the Eurozone and the US. The accompanying investigation features these patterns and the fundamental elements.

Intermediate Trends

Trade Wars (2018-2019): Flaaen and Penetrate (2019) stated that the US forced tariffs on a few exchanging accomplices, including the European Union, which prompted retaliatory measures from the impacted nations. These trade tensions added to vulnerability in worldwide business sectors, prompting changes in the EUR/USD fluctuations.

Brexit (2018-2020): The Brexit discussions between the UK and the European Association created vulnerability in the Eurozone, influencing the EUR's value. Although the final Brexit agreement was signed in December 2020, the ongoing adjustments to the new economic relationship continued to impact the EUR/USD exchange rate (Lewis, 2020).

Geopolitical Risks and Commodity Prices (2018-2023): Beckmann et al. (2020) showed that adjustments in commodity prices, especially oil costs, have impacted the EUR/USD exchange rate. Geopolitical events, for example, the strains between the Russia-Ukraine struggle, have impacted market feeling and added to fluctuations in the EUR/USD conversion standard because of the commodity price shocks (Sokhanvar & Bouri, 2023).

Primary Trends

Monetary Policy Divergence (2018-2019): During this period, the European Central Bank (ECB) kept an accommodative monetary policy stance (ECB, 2019), while the Federal Reserve (Fed) pursued monetary tightening (FED, 2019). This led to a stronger USD and a weaker EUR. Also, the Fed increased interest rates multiple times, while the ECB maintained negative interest rates and continued its asset purchase program. The widening interest rate differential between the two currencies started to contribute to the appreciation of the USD.

COVID-19 Pandemic (2020): The outbreak of the COVID-19 pandemic led to significant economic disruption and uncertainty. According to Milstein & Wessel (2021), Meyer & Caporal (2021), central banks around the world, including the ECB and the Fed, implemented aggressive monetary easing measures to support their economies. However, according to Estevao (2022), the pandemic-induced economic downturn resulted in a flight to safety, as investors flocked to the USD, driving the value of the currency higher against the EUR in 2022 (Figure 1).

Figure 1. US dollar to euro spot exchange rate in 2022 (Source: Ilzetzki & Jain, 2023)

Post-Pandemic Recovery (2021-2022): Also, according to Edelberg and Sheiner (2021), the U.S. economy's faster recovery, supported by massive fiscal stimulus packages, led to expectations of monetary tightening by the Fed (Figure 2).

Figure 2. The effect of Bidens $1.9 trillion fiscal package (Source: Edelberg & Sheiner, 2021)

This fueled an appreciation of the USD against the other currencies, especially EUR (Figure 2).

Figure 3. DXY Dollar Spot Index from 2021 to 2022 (Source: Estevao, 2022)

However, the Eurozone's economic recovery and ongoing monetary policy measures from the ECB also supported the EUR, leading to a more balanced EUR/USD exchange rate (Colville & Benniger, 2022).

Future Exchange Rate

During this March meeting, the Fed raised interest rates by 25 basis points, as the market had expected, despite ongoing unrest in the worldwide financial industry (Winter, 2023). This is the ninth sequential rate climb of the Fed since March, to 4.75-5%, the most noteworthy since September 2007.

However, at this gathering, the Fed did not rehash the explanation that "continuous increases" are required for "a few extra increments," as they observed the effect of the rate climbs for the financial area precisely and for the economy overall.

In the interim, the ECB on Walk 16 raised interest rates by 50 basis points, over two times the pace of the Fed (Amaro, 2023). This is the sixth back-to-back ECB since July last year.

Consequently, the restricting loan fee hole between the US and Europe made the euro ascend to a 7-week high of $1.0930 on March 23, likewise the sixth continuous session of EUR gains.

Prior, the Swiss National Bank (SNB) likewise raised its strategy rate by 50 basis points as it battled to figure out how to offset tending to expansion with worries about monetary market instability while at the same time raising its arrangement rate by 50 basis points (Ward-Glenton, 2023) and emphasizing that they will be dynamic in the foreign exchange market.

In this way, the dollar fell for six successive meetings, denoting the most extended series of failures in 2.5 years, after the FED seemed, by all accounts, to be moving toward the mark of discontinuous interest rates climbs, while the SNB and the ECB move forward with additional rate hikes.

Accordingly, for the time being, EUR/USD will keep increasing.

TestingIRP, PPP, and IFE

IRP,PPPand IFE are commonly used parity theories in the field of international finance, which are designed to explain the relationship between currency exchange rates of different countries. Here is an overview of these theories and how they are tested. IRP means that there should be an equilibrium relationship between the interest rates of different national currencies, which should be reflected in the exchange rates of currencies. In short, IRPs indicate that currency exchange rates should reflect interest rate differentials. To test the IRP, researchers need to compare interest rates in two countries and convert them into the same currency. If the IRP holds, the exchange rate between the two countries should match the difference in interest rates between the two countries. As the four-quadrant scatter chart shows, there is a divergence between the euro and the dollar. The PPP refers to the price level of different countries should bebalanced;this kind of balance should reflect between currencies. In short, PPP suggests that currency exchange rates should reflect the difference in prices between two countries.

To test PPP, researchers need to compare the price levels of two countries and convert them into the same currency. If PPP holds, the exchange rate between the two countries should reflect the difference in prices between the two countries. Compare the euro and the dollar, for example, the common price of a pair of identical shoes is 110 euros in Europe and 120 dollars in the United States. 110*1.1042=121.62 USD, the average value is 1.15 after calculation, so their prices are basically balanced.

IFE refers to the currency exchange rates should reflect the difference between different countries the rate of inflation. In a nutshell, the IFE states that currency exchange rates should reflect the difference in inflation rates between two countries. To test the IFE, the researchers compare the inflation rates of the two countries and convert them into the same currency. The calculated depreciation of the euro should also increase slightly.

Forecasting Exchange Rate

Technical forecasting: Using technical indicators and chart analysis to predict future exchange rate movements byanalysinghistorical exchange rate data and market trends.

Technical forecasts can provide short - and medium-termforecasts butmay be less accurate for long-term forecasts. Based prediction: through the analysis of economic fundamentals (such as inflation, unemployment, GDP, etc.) to predict currency movements.

Base forecasts are usually suitable for long-termforecasts butcan be influenced by market sentiment in the short term. Market forecast: through the analysis of thebehavioursof market sentiment and market participants to predict currency movements. Market forecasts can provide short - and medium-termforecasts butcan be affected by market noise and human factors. Prediction: use historical rate data and technical index, analysis of the movements of currency pairs and trend. Based on technical analysis, the exchange rate trend in 1 month and 3 months is predicted as follows:

1 m: Forecast to move between 103.00 and 105.00.

3 m: forecast exchange rate from 101.00 to 106.00.

Base forecast: Forecast the exchange rate trend byanalyzingthe fundamental economic data. Based on the basic analysis, the exchange rate trend in 1 month and 3 months is predicted as follows:

1 m: Forecast to trade between 103.50 and 104.50, subject to inflation and GDP growth.

3 m: forecast will be between 101.00 and 104.50 exchange rate fluctuations, affected by the unemployment rate and international trade.

Market prediction: Byanalysingmarket sentiment and participants'behaviours, the exchange rate will be predicted. Based on market analysis, the exchange rate trend in 1 month and 3 months is predicted as follows:

1 m: Forecast to trade between 103.00 and 105.00.

Economic and market-level uncertainty may have an impact on the exchange rate as EURUSD moves between 103-105. Here's what's possible: The impact of macroeconomic data on exchange rates is huge. When economic data is released that is better than expected, such as GDP,inflationand employment figures, this usually causes the euro to rise and the dollar to fall. Conversely, if the data is poor, then the dollar couldriseand the euro fall. The monetary policies of the European Central Bank and the U.S. Federal Reserve are one of the main influences onexchange rate fluctuations. If one central bank decides to raise interest rates or scale back monetary policy stimulus, that could cause its currency to rise and another to fall. Political events and risks can also affect exchange rates. For example, if the EU faces political turmoil or trade disputes, the euro could fall. Conversely, if the U.S. economy faces risks, such as a massive natural disaster or diplomatic incident, the dollar may fall. Market sentiment can also have an impact on exchange rates. If investors are optimistic about a currency, that can cause it to appreciate, and vice versa. This sentiment can vary depending ona number offactors, such as global market turmoil, stock market performance, news coverage, etc. While exchange rates that fluctuate between 103 and 105 are generally considered relatively stable, these factors can still have an impact on exchange rates.

Reference

Sokhanvar, A., & Bouri, E. (2023). Commodity price shocks related to the war in Ukraine and exchange rates of commodity exporters and importers. Borsa Istanbul Review, 23(1), 4454. https://doi.org/10.1016/j.bir.2022.09.001Beckmann, J., Czudaj, R. L., & Arora, V. (2020). The relationship between oil prices and exchange rates: Revisiting theory and evidence. Energy Economics, 88, 104772. https://doi.org/10.1016/j.eneco.2020.104772FED. (2019, February 22). Monetary Policy Report February 2019. Board of governors of the Federal Reserve System. https://www.federalreserve.gov/monetarypolicy/2019-02-mpr-summary.htmLewis, C. (2020, December 9). EUR/USD price forecast - euro noisy ahead of Brexit decision. FXEMPIRE. https://www.fxempire.com/forecasts/article/eur-usd-price-forecast-euro-noisy-ahead-of-brexit-decision-687595Meyer, V., & Caporal, J. (2021, February 23). The shifting roles of monetary and fiscal policy in light of covid-19. CSIS. https://www.csis.org/analysis/shifting-roles-monetary-and-fiscal-policy-light-covid-19Milstein, E., & Wessel, D. (2022, March 9). What did the Fed do in response to the COVID-19 crisis?. Brookings. https://www.brookings.edu/research/fed-response-to-covid19/Edelberg, W., & Sheiner, L. (2022, March 9). The macroeconomic implications of Bidens $1.9 Trillion fiscal package. Brookings. https://www.brookings.edu/blog/up-front/2021/01/28/the-macroeconomic-implications-of-bidens-1-9-trillion-fiscal-package/ESTEVO, M. (2022, August 4). Three ways a strong dollar impacts emerging markets. World Bank Blogs. https://blogs.worldbank.org/voices/three-ways-strong-dollar-impacts-emerging-marketsColville, R. (2022, December 19). EUR to USD forecast: Can the US dollars strength continue into 2023? Forbes. https://www.forbes.com/advisor/money-transfer/usd-eur-forecast/Ilzetzki, E., & Jain, S. (2023, February 17). Euro weakness in 2022. CEPR. https://cepr.org/voxeu/columns/euro-weakness-2022Amaro, S. (2023, March 16). European Central Bank hikes rates despite market mayhem, pledges support if needed. CNBC. https://www.cnbc.com/2023/03/16/ecb-rate-decision-march-meeting-lagarde-announces-new-rate-hike.htmlWinters, M. (2023, March 22). The Fed is expected to raise interest rates, despite recent banking turmoil: this will be a game-time decision. CNBC. https://www.cnbc.com/2023/03/22/the-fed-is-expected-to-raise-interest-rates-despite-banking-turmoil.htmlWard-Glenton, H. (2023, March 23). Swiss central bank hikes interest rates by 50 basis points despite Credit Suisse turmoil. CNBC. https://www.cnbc.com/2023/03/23/swiss-central-bank-hikes-interest-rates-by-50-basis-points-despite-credit-suisse-turmoil.html