USD/EUR Exchange Rate: Expectations and Risk Premiums Drive, Not Yield Spread
Exchange rate expectations and risk premiums for unexpected euro depreciation have been driving the USD/EUR exchange rate since early 2017, rather than the yield spread, according to KfW Research.
Frankfurt – The yield spread between the US dollar and the euro has not explained the USD/EUR spot rate since the beginning of 2017, according to research from KfW. While the US dollar's yield advantage has steadily increased, the euro has appreciated against the dollar in trend.
Other factors are currently dominating exchange rate developments, including expectations for the exchange rate and risk premiums for unexpected euro depreciation. Exchange rate expectations increased from early 2017 until April 2018, driven by the anticipation that the US dollar's yield advantage will diminish in the future.
Consequently, recent euro weakness is expected to reverse when investor nervousness regarding Italy subsides and the European Central Bank (ECB) confirms its exit from unconventional monetary policy. KfW is a German state-owned development bank.