The EUR/USD is the most traded and most liquid currency pair in the FX market. In fact, it is the most liquid asset in the world. For anyone looking to trade EUR/USD, its status as the most liquid means unique strategies may be needed.
To really have a comprehensive view on how to trade the EUR/USD, you also need to have a solid grasp of the fundamentals. These fundamentals underpin the volatility in the exchange rate.
The economic data from the Eurozone impact the EUR/USD as well as the other euro crosses. When you make decisions to trade EUR/USD, these factors should be among your considerations. Much of the economic data from the Eurozone is not market-moving and ought to be ignored. Instead, we need only to study those economic reports that have the potential to drive volatility higher. Also, we should consider those that can promote trend development.
Main European Economic Releases That Move EUR/USD
Economic data drive help to forecast monetary policy. The European Central Bank (ECB) is responsible for establishing the monetary policy of the euro currency area. Subsequently, the ECB’s monetary policy is the main driver of the euro exchange rate. It also has a long-lasting effect on the euro trend development. For traders, these releases are key pieces of information when developing plans to trade EUR/USD effectively.
However, monetary policy is based on economic data. Gauging these fundamental data can help you better forecast the monetary policy. Subsequently, it can help you forecast the short-term and long-term EUR/USD trends.
We’re only concerned about those economic data that will tell us what the ECB will do because the inherent return on owning a currency is the interest rate. In the same way, the inherent return on owning a stock is the dividend yield. Similarly, the inherent return on owning a bond is the interest assigned to that bond.
The interest rate is going to determine the demand for that asset. If the data doesn’t tell us anything about where that’s going, that economic data is not that significant.
So, what are the European economic releases that impacts the euro? Savvy investors looking to trade EUR/USD watch these closely for signals.
Firstly, inflation is probably one of the most significant pieces of data that drives the ECB monetary policy. Currently, the ECB aims to keep inflation close to 2% to achieve its monetary objectives. The next factor that impacts the EUR/USD exchange rate is the GDP economic growth activity. The Eurozone GDP is released at the end of each quarter.
The Bund–Treasury Yield Spread: A Key Way to Trade EUR/USD
The yield spread between the US 10-year Treasury yields and German 10-year yields is an important factor that governs how the EUR/USD exchange rates move. The bond yields are an excellent instrument to gauge the demand for one’s currency. They can give us a good measurement of where the interest rates might go in the near future. Additionally, yield spreads are often analyzed by those wishing to trade EUR/USD successfully.
The Bund – Treasury yield spread is simply the difference between the USA and German’s bond yield. The higher bond yield currency will appreciate against the lower bond yield currency because it will earn you more money. In the FX space this is also known as the carry trade. Importantly, it is an important concept for those who focus on ways to trade EUR/USD in different market conditions.
In other words, when the Bund – Treasury yield spread is raising the EUR/USD exchange rate is also rising. Conversely, when the Bund – Treasury yield spread is falling the EUR/USD exchange rate will decrease.
As we can observe, the bond yield spread can be used to forecast the EUR/USD exchange rate. Human behavior will always be the same. Thus, investors will always chase the higher yielding currency over a lower yielding currency. This is done to take advantage of the carry trade, which is another popular strategy to trade EUR/USD efficiently.
Trading Divergence to Trade EUR/USD
Beside the carry trade, you can also trade those instances where there is divergence between the bond yield spread and the EUR/USD exchange rate. For example, if the EUR/USD exchange rate is rising but the bond yield spread is not, at least in theory you should be getting ready to short EUR/USD. Alternatively, you can find other ways to trade EUR/USD based on your analysis.
A top-down analysis of the EUR/USD will obviously include looking on the other side of the monetary policy spectrum aka the US economic data releases that drive the greenback. The entire currency market is dictated heavily by what the US dollar does. This means that the EUR/USD exchange rate can have a profound influence on the broad Forex market. Especially, this is true for those who actively trade EUR/USD as part of their portfolios.
