The correlation between the EUR/USD and interest rate outlook spread has started to strengthen. After the ECB cut rates to 1.25% the interest rate outlook for the Euro turned positive which has narrowed the spread between it and the dollar to -11 from -84. President Trichet following the rate decision signaled that next month could see the committee pause their easing policy which is a driving factor in the increased expectations. Although the spread is still showing a bearish signal, we could see it turn bullish as we approach the next policy decision. Indeed expectations for the U.S. don’t figure to rise with the economy showing continued weakness.
However, the ECB also forecasted that they would make a decision on taking quantitative easing measures which could be a weighing factor for the Euro and wouldn’t be reflected in the interest rate outlook. Therefore, traders shouldn’t assign significant weight to yield differentials when making trade decisions.
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