The currency pair EUR/USD is the abbreviated term for the euro-US dollar pair, or cross, between the European Union (EU) and the United States of America (USD). The currency pair shows how many dollars (the quoted currency) one euro (the base currency) must purchase. The EUR/USD currency pair is often known as “euro trading,” and the EUR/USD pair’s value is 1 euro for x US dollars. For instance, if the liquidity providers tier 1 is trading at 1.70, one euro costs 1.7 US dollars.
Basics of Currency Pair: EUR/USD (Euro/U.S. Dollar)
The EUR/USD pair has become the most widely traded pair globally because it reflects a union of two of the world’s largest economies, the EUR/USD pair has become the most commonly traded pair globally. It is influenced by factors that affect the value of the euro or the US dollar concerning other currencies and each other. As a result, the interest rate disparity between the European Central Bank (ECB) and the Federal Reserve (Fed) impacts the relative value of these currencies.
When the Fed intervenes in open market activities to strengthen the US dollar, the EUR/USD cross could fall in value as the US dollar strengthens against the euro. Similarly, negative news from the EU economy harms the EUR/USD pair’s pricing. Significantly, the news of Italy’s and Greece’s government debt crises and migrant surge triggered a euro selloff, sending the pair’s exchange rate.
Reading a EUR/USD Price Chart
The price displayed on the EURUSD chart for the currency pair indicates the exchange rate of the two currencies, unlike a price chart for a stock, where the indicated price directly represents a stock price. As a result, a chart’s directional signal matches the base currency. It’s vital to remember that the pair’s base currency is fixed and always represents one unit.
Dominant currency pricing
The traditional view of exchange rates is based on the notion that enterprises set their prices in their local currencies. When the home currency weakens, domestically produced products and services become cheaper for trading partners, resulting in increased demand from them and, as a result, increased exports.
When a country’s currency depreciates, imports become more expensive in-home currency terms, causing customers to favor domestically produced goods over imported goods. As a result, if prices are fixed in the exporter’s currency, a weaker currency might aid the recovery of the local economy following a negative shock.
However, evidence is mounting that most global trade is invoiced in a few currencies, the most prominent of which is the US dollar—a phenomenon known as Dominant Currency Pricing or Dominant Currency Paradigm. Countries’ share of US dollar trade invoicing vastly outnumbered their share of US trade.
This is primarily true in emerging markets and developing economies (EMDEs), which are becoming increasingly crucial for the international monetary system as their position in the global economy grows.
The introduction of the euro temporarily weakened the US dollar’s supremacy, but it has remained essentially unabated since then. However, other reserve currencies have a minor role to play.
The use of dominant currencies such as the US dollar in pricing choices changes how trade flows react to exchange rates, particularly short-term. When export prices are established in US dollars or euros, depreciation does not make goods and services cheaper for overseas customers, at least not in the short term.
Thus, there is little incentive to raise demand. As a result, in EMDEs where dominant currency pricing is more widespread, the response of export quantities to the exchange rate is more muted, as is the short-term boost to the home economy from a depreciation.
Another critical consequence of using the US dollar in trade pricing is that a global strengthening of the US dollar causes trade contraction in the short term. This is because the depreciation of other nations’ currencies against the US dollar results in higher domestic currency pricing for imports, particularly those from countries other than the US, and consequently weaker demand for them.
Dominant currency financing
The US dollar’s dominance is also a feature of corporate financing in emerging nations. This feature, known as Dominant Currency Financing, illustrates that swings in exchange rates can impact firm balance sheets. A depreciation that raises the value of a company’s liabilities relative to its revenues weakens its balance sheet and makes it difficult to get additional capital as the company’s ability to repay deteriorates. However, this effect depends on whether revenues are received in foreign or local currency.
Also, exporting companies that use the US dollar or euro for pricing and financing are “naturally hedged” since obligations and revenues move in lockstep when exchange rates shift. This means that foreign currency financing is less of a worry for exporting enterprises.
However, importing enterprises’ revenues and liabilities are frequently mismatched, and exchange rate swings cause balance-sheet implications that limit financing and import quantities. Dominant currency finance amplifies the impact of a country’s devaluation on imports.
Bottomline
According to market participants, the dollar is expected to weaken versus the euro. However, European officials are likely to take actions to slow the euro’s ascent to promote the formation of a more orderly and less turbulent market. Who will receive assistance? Exporters of American goods to Europe may expect another successful year. Significantly, importing companies in the United States should protect themselves by hedging in foreign exchange markets.
