HSBC indicates that the EUR/USD exchange rate has risen mainly due to speculative flows rather than traditional economic factors. The bank’s tracker shows that current market dynamics have sidelined interest rate differentials and risk sentiment.
The valuation of EUR/USD appears overstated compared to rate differentials. Although the 2Y spreads temporarily favoured the euro, the increase in the exchange rate has exceeded those changes, with recent narrowing in spreads not reflected in a decline in EUR/USD.
Impact Of Speculation On Exchange Rate
The exchange rate’s sustainability now hinges on swift execution of EU fiscal stimulus measures. Any delays in fiscal plans may lead to a rapid reversal of speculative positions.
HSBC’s findings highlight a market primarily driven by speculation rather than fundamentals. The usual forces that move the exchange rate—interest rate gaps and overall market confidence—have lost influence. Instead, traders adjusting positions based on shifting sentiment seem to be the dominant force behind price moves. This has created a situation where value measures are disconnected from actual policy differences.
The bank’s data shows that compared to interest rate spreads, the euro appears overbought. At one point, a brief gap in two-year bond yields leaned in the euro’s favour, but the currency’s rise went far beyond what those changes justified. More recently, those spreads have edged back, yet EUR/USD has not followed downward. That suggests positioning has been shaped by other forces, with traders holding on despite market shifts that would usually prompt a rethink.
Potential Market Reactions
What happens next depends on whether promised EU fiscal measures reach the market quickly. Delays could unsettle traders and lead to an abrupt shift in positions. Those who have built trades expecting strong European stimulus may unwind them if execution stalls. Because markets have already moved ahead of actual fiscal steps, any perceived holdup could provoke a reaction stronger than usual.
For those navigating these fluctuations, this means paying closer attention to policy momentum rather than just relative rate moves. Given how much speculation has entered the equation, shifts in sentiment could come faster than usual.
