The early 2020 dip in EUR/USD, to its lowest level since April 2017, did not prove to be the sustained break higher in the USD that some had anticipated, with the move aggressively unwinding over the course of the following week. The rush to close overweight USD positions helped drive the move, with the latest leg lower in the USD coming as a result of the intra meeting Fed rate cut.
There are several reasons why the USD had appeared relatively attractive coming into 2020. Of note, higher yields on US assets and negative rates in the eurozone enticed market participants into the carry trade. However, the coronavirus led to rising expectations of a Fed rate cut – which arrived on Tuesday (3 March), crushing carry and with it the appeal of the USD.
Investors had also been positioned for a stronger USD for reasons other than carry. At the start of the coronavirus outbreak, markets became convinced that the US was less economically exposed to China than Europe. This reinforced the market view that the USD was a safe haven currency. However, with the virus epidemic now spreading more rapidly outside of China, assumptions that it will have only a moderate impact on US growth have been cast aside.
Figure 1: Spread in 1-Year Forward 1-Month USD and EUR OIS