Data Shows That Euro Area and US Interest Rates Are Almost Irrelevant To EUR/USD Exchange Rate

A higher-yielding currency will appreciate against a lower-yielding one. This assumption is absolutely basic for fx traders, especially those who have any knowledge of fundamentals. It is logical and it is true. Investors will buy a currency that can be deposited for higher interest. But as usual, the devil is in the detail. 

The data from the chart below clearly shows that it is difficult to find any correlation between EUR (red line) and USD (blue line) overnight LIBOR rates and the EUR/USD exchange rate (green line).

USD, EUR LIBOR overnight rates, EUR/USD exchange rate

The EUR/USD rate has been constantly growing between 2000 and 2008. Roughly half of this time, EUR interest rates were higher, the other half - USD rates were higher. After 2008, there were no rules either. The sharp drop of EUR value against the USD started when the euro rates were still significantly higher. After 2016, the euro rates dived below zero, and US rates went up to over 2%. As a result, the fall continued, but at a slower pace.

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We have measured the correlation between US and EUR rates and the EUR/USD exchange rate. In the case of US rates we should expect a negative correlation - the higher the US interest rate, less dollars should be paid for 1 euro. Conversely, for EUR rates, the correlation should be positive - the EUR value measured in dollars should be higher when the EUR interest rate grows.

Indeed, we observed some very low correlation between the USD overnight LIBOR and EUR/USD exchange rate. The value of the correlation coefficient was -0.103. As a general rule, when the correlation between variables is lower than 0.2, they are not included in economical models. To sum up, the correlation is there, it has the expected direction, but it's insignificant. 

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In the case of the EUR interest rate, we observed its negative correlation with the EUR/USD exchange rate. It was even lower than in the case of USD - the correlation coefficient was -0.039. Such low value, in fact, means no correlation, but still, the direction came as a surprise. 

There can be only one explanation. The difference in EUR and USD exchange rates was so insignificant, that other fundamental factors became more important. 

This data puts investors' overexcitement with Fed and ECB meetings in a new perspective. They simply hardly matter in the long run.  

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