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CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 69% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
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Why euro remains strong

Article By: ,  Financial Analyst
April 7, 2014 4:29 PM

Look at short-term yield differentials in order to understand the so-called mystery of the euro’s outperformance relative to the US dollar over the last 6 months. Reserve managers’ systemic euro buying on the dips in the absence of ECB easing indications has been frequently cited as the reason to the euro’s outperformance. Cheaper Eurozone equity valuations relative to the US have also been included.

Can’t ignore that EUR-USD LIBOR spread

The 3-month LIBOR EUR-USD spread (EUR minus USD) shows the differential is at 0.061%, the highest level since July 2012.

The charts below indicate the improving spread in 3-month libor in favour of EUR, reflecting the declining chances of ECB easing as well as falling demand for USD-funding.

Recall that during rising volatility and falling euro, cost of USD rises, which lifts up USD-libor. During times of crisis (rising Eurozone bond yields & falling euro), the cost of USD funding (USD-LIBOR) was boosted by Eurozone banks’ rush into raising USD funds to alleviate the unfolding liquidity crunch.

Today is the opposite case: Improved macro and market conditions in the Eurozone manifested by rising business surveys and falling bond yields are seeing 3-month EUR-LIBOR at 0.29%, the highest since July 2012, while 3-month USD-LIBOR is at 0.23%.

Euro’s real yield differential means US yields not high enough

Another spread is that of real 2-year yields (German 2-year yields minus Ezone CPI at -0.33%) minus (US 2-year yields minus core PCE at -0.69%), which remains in favour of German yields at +0.37%. This means that despite US yields being above their German counterpart, they’re not sufficiently priced to account for the higher inflation differential with the Eurozone, considering Eurozone CPI at 0.5% y/y and US core PCE at 1.1%.

The 3rd chart shows the continuous decline in EURUSD 1-month call option volatility, which has proven to be generally inversely related to the spot EURUSD.  Falling EUR volatility is part and parcel of the decline in global equity volatilities resulting from acommodative policies in the US and the UK. Any indications that prolonged declines in volatility become associated with expectations of ECB quantitative easing could imply that action in Frankfurt would actually boost the euro as was the case in LTRO-1 and LTRO-2, instead of its decline.

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