Question

In: Finance

Evaluate the EUR/USD - Euro US Dollar currency pair. Adjust the time horizon to range 2002...

Evaluate the EUR/USD - Euro US Dollar currency pair. Adjust the time horizon to range 2002 to-date.

a. Identify any dramatic changes and do a brief research on the internet to explain such movements.

b. In addition, do you observe an changes or trends during 2007-2014?What do you think were the causes of such changes or trends? Do a brief research on the internet to support your answers.

Solutions

Expert Solution

a. The dramatic changes and reasons for such movements in EUR/USD currency pair from 2002 to-date are as follows

Euro came into existence on 1 January 1999. In 2002, the French Franc, the German Deutschmark, the Spanish Peseta, the Italian Lira, etc. ceased to have separate and were folded into the shared currency, Euro. Thus in 2002,  Euro became a physical currency.

Post the introduction of Euro, the strength of the underlying economy and monetary policy played an important role in affecting dramatic changes in exchange rates of the currency pair. With the global financial crisis in 2007, the history of Euro Vs USD witnessed one of the biggest reductions. On 18th September 2007, the US Federal Reserve stimulated the economy by reducing the Fed rate by 50 basis points. On the other hand, European Central bank resisted quantitative easing with an objective of stability in prices. Hence, Euro strengthened against the Dollar with the onset of Financial Crisis.

Any major event that impacted the movements in the Euro USD currency pair was the Eurozone Debt Crisis. In October 2009, Euro weakened against Dollar with the revision of deficit forecasts from 6.7% of GDP to 12.7% of GDP by the Greek government.

In 2015, ECB finally began purchasing sovereign bonds as a stimulus measure, which was several years behind the FED's introduction of QE. As a result, when ECB introduces full blown QE in January 2015 the Euro weakened against dollar.

Later in December 2015, the Euro started strengthening against Dollar when Fed hiked interest rates for first time in a decade after 2009 Financial Crisis. On 24th June 2016, the United Kingdom voted to leave the European Union. As a result, the Euro fell because the traders predicted that the consequences of Brexit would weaken the European economy.

In 2018, Investors hoped the ECB would end its QE program and begin raising interest rates. As a result Euro fell from $1.2 to 1.12 in March 2018. For a brief time, Euro strengthened against Dollar when investors feared President Trump's tax plan would increase the U.S. debt.

In 2019, Euro fell throughout the year as investors concerned about the decline of global trade due to Trump's trade war bought US dollars. By Mid-March Europe was hard hit by the Coronavirus pandemic which led to weakening of Euro against Dollars. Later by July, US took the lead in the cases while the number of corona cases in Europe started declining which led to Euro rising to $1.18.

b. Trends and causes for change in the currency pair movements during 2007-2014 are as follows -

During the onset of subprime mortgage crisis, Investors remained confident that the crisis would be confined for the most part to the United States. This led to Euro's strength against dollars until investors realized that the recession was going to be global.

In 2009, the investors witnessed a contrast in the monetray policies of ECB and Fed. Euro which started strong at $1.40 in the start of the year, fell to the year's low of $1.25 as the European Central Bank (ECB) increased its benchmark interest rate to 1.5%.

Later ECB realized that its strategy had backfired and began lowering its prime rate. As a result, the euro’s value rose by 20% between March 3 and Dec. 1. In addition, investors' fears of the $13 trillion U.S. debt caused them to flee the dollar and dollar-denominated bonds.

In 2011, investors feld to Euro due to the fear of U.S. debt default crisis.At the same time, the ECB raised its key interest rate to 1.5%, which increased bank rates for anyone lending or saving in euros, thus raising the value of the currency itself.

By the end of 2011, the investors started doubting the EU's financial strength and the future viability of the euro itself in response to a flare-up of the Greece debt crisis. In May, the euro plummeted to $1.24 as the Greek debt crisis worsened.

In 2013, FED announced that 'tapering' of stimulus will begin in January 2014. As a result, Euro weakened against Dollar into February 2014. In July 2014, ECB president Mario Draghi prepares the market for QE which led to further fall of Euro.

In October 2015, the ECB announced that it would lower interest rates. It also said that Greek banks must raise $15.9 billion to cover bad debt. This put downward pressure on the euro as investors feared a revival of the Greek debt crisis. At the same time, the U.S. Federal Reserve raised the federal funds rate in December 2015. This action drove the euro down to $1.07.

On 24th June 2016, the United Kingdom voted to leave the European Union. As a result, the Euro fell because the traders predicted that the consequences of Brexit would weaken the European economy. By September 2017, Europe began looking like a stronger economic bet after investigations into the connections between President Donald Trump's administration and Russia worried investors.


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