A notable feature of currency markets in recent days has been the moves in the euro-dollar currency pair. Last week, it traded up into the $1.15-1.16 level for this first time since late 2018.
It started this week continuing its ascent, breaking up into the $1.17-1.18 territory, trading to a 22-month high in the process.
The EUR-USD rate had been mostly confined to a narrow $1.07-$1.15 corridor since the autumn of 2018. Over the last two years or so, the dollar had been benefitting from the strong US economy and relatively high US interest rates vis-à-vis the eurozone.
Meanwhile, over the first half of this year, the currency had been supported by its safe-haven status and associated market flows at a time of elevated uncertainty.
However, over the last number of weeks, EUR/USD has been trading higher, towards the upper end of this range, before breaching it last week. It has gained around 4% this month.
An important factor in these moves has been a general weakening of the dollar across the board. This softening trend for the currency has occurred amid an ongoing improvement in investor sentiment and therefore reduced safe-haven demand for the dollar.
When Covid-19 related risk aversion on markets was at its height back in March, the dollar saw strong demand, benefitting from a flight to safety.
This was reflected in EUR/USD falling to a low of $1.064. Since then, with equity markets registering gains of between 30%-40%, the dollar has fallen by around 8% on a trade-weighted basis.
The move higher in EUR/USD has also been helped by a firming in the euro. The euro has been supported over the last number of weeks by developments in relation to an EU recovery fund. This culminated in EU leaders agreeing on a €750bn fund for the region.
The deal included €390bn in grants, as well as sharing the financing burden of the fund through debt mutualisation. The agreement is both politically and economically significant for the EU.
Looking ahead, it is challenging to call the next move in EUR/USD. This is because of the heightened uncertainty and unpredictability attached to how the Covid-19 pandemic evolves and the impact this will have on the global economy and financial markets.
In the near term, it is worth noting that market positioning is very short the dollar which may offer some support to the currency.
A return to heightened risk aversion on markets, potentially prompted by new concerns over the economic outlook, would likely result in a flight into the dollar.
In such a scenario, EUR/USD would be expected to weaken from its current levels, giving up much of its recent gains.
Another factor to bear in mind is monetary policy/interest rate differentials. Money market rates in the eurozone are expected to remain in negative territory well into the second half of this decade, which is likely to act as a headwind for the euro.
On the other hand, if a sustained strong global recovery started to take hold over the coming months, EUR/USD could maintain its upward momentum.
It may also be the case, that the market starts to focus and differentiate on how Covid-19 is evolving in both regions and the implications this has for their respective economies.
At the moment, the newsflow in this regard has been more negative for the US in comparison to the eurozone.
Although, a move above $1.20 would be difficult, as the pair has not been above this level since 2014, except for a brief period in the first half of 2018.
Finally, the upcoming US presidential election has the potential to add further volatility to the dollar.
-John Fahey is senior economist at AIB