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EUR/USD: Fed To Cut Rates By 25 Basis Points

18th September 2019

A liquidity injection by the Fed and investor expectations that the Fed will cut interest rates sent the euro US dollar exchange rate charging northwards in the previous session. The pair rallied to a high of US$1.1075 where it closed the session. The pair is easing lower in early trade on Wednesday.

What do these figures mean?

When measuring the value of a pair of currencies, one set equals 1 unit and the other shows the current equivalent. As the market moves, the amount will vary from minute to minute.

For example, it could be written:

1 EUR = 1.12829 USD

Here, €1 is equivalent to approximately $1.13. This specifically measures the euro’s worth against the dollar. If the U.S. dollar amount increases in this pairing, it’s positive for the euro.

Or, if you were looking at it the other way around:

1 USD = 0.88789 EUR

In this example, $1 is equivalent to approximately €0.89. This measures the U.S. dollar’s worth versus the euro. If the euro number gets larger, it’s good news for the dollar.

The mood for the euro picked up in the previous session, thanks in part to improved economic sentiment in the region. The ZEW survey of financial experts showed that expectations surrounding the German economy picked up in August, after falling across previous months. The easing of tensions between the US and China in recent weeks is helping boost confidence in exporter nation Germany. ZEW German economic sentiment lifted from -44.1 to -22.5. This is clearly a large improvement. However, the figures are still gloomy compared to the long-term average.

Today investors will look towards eurozone inflation data. Analysts are forecasting that inflation will have increased 0.25 month on month in August. This would be a significant improvement on July’s -0.5% decline. However, on an annual basis, analysts predict that inflation will remain at a lacklustre 1%. This is well below the European Central Bank’s (ECB) 2% target. Low inflation will support the ECB’s recent move to loosen policy. Further weakness could prompt more action from the ECB.

FOMC Awaited

The dollar was broadly out of favour in the previous session after the Federal Reserve injected liquidity into the financial markets to the tune of $75 billion. This was to help ease the overnight banks’ borrowing rate, also known as the repo rate. The move by the Fed addressed a dislocation between overnight funding needs and overnight funding. The Fed’s intervention weakened the value of the dollar.

Today the dollar could come under further pressure as investors turn their attention to the FOMC. Analysts broadly expect the Federal Reserve to cut interest rates by 0.25%, for the second time this year. In addition to the rate cut, investors will be paying close attention as to whether the Fed have any further cuts planned for the rest of this year. Any hints of further cuts could pull the dollar lower

Why do interest rate cuts drag on a currency’s value?

Interest rates are key to understanding exchange rate movements. Those who have large sums of money to invest want the highest return on their investments. Lower interest rate environments tend to offer lower yields. So, if the interest rate or at least the interest rate expectation of a country is relatively lower compared to another, then foreign investors look to pull their capital out and invest elsewhere. Large corporations and investors sell out of local currency to invest elsewhere. More local currency is available as the demand of that currency declines, dragging the value lower.