Euro Surges Against US Dollar Despite Negative Rates

  • 27 Aug 2020
  • By Erik Norland

By mid-August the euro (EUR) rose to its highest level against the US dollar (USD) since May 2018 (Figure 1).  There are several possible reasons for EUR’s strength:

  1. Europe continues to enact fiscal stimulus measures.
  2. Uncertainty over outcomes of the US elections in November.
  3. Negative rates, paradoxically.
  4. The course of the pandemic is diverging between the continents.

Figure 1: EURUSD has recovered to its highest level since May 2018

Different paths for fiscal stimulus

During the initial phase of the pandemic response, Europe and the US followed a similar course when it came to fiscal policy -- government spending soared and tax receipts dwindled, deepening budget deficits to levels not seen during peacetime. 

From July, however, the US and eurozone’s fiscal paths began to diverge.  The eurozone enacted a 700- billion euro continent-wide rescue package – the first of its kind.  It may be the first step towards a common eurozone fiscal policy, though politicians were careful not to define it as such since the concept of a unified fiscal policy remains controversial, particularly in Northern Europe. 

By contrast, the US Congress and White House have been unable to agree on a second set of fiscal measures, as of this writing.  As a result, supplemental unemployment benefits were cut back on August 1 from $600 per week to $300 in states that have chosen to participate.  As of August 25, 30 of the 50 states had agreed to participate, and 13 of them also included an additional $100 per week in benefits.  Also, a portion of the US payroll taxes has been deferred till next year but unless Congress enacts legislation making it into an actual tax cut, deferred payroll taxes will accumulate to be paid in January. 

The upcoming US elections may also be putting the dollar under downward pressure.  For the moment, the outcomes of the Presidential and Senate elections, in particular, appear to be uncertain.

Negative Rates in Eurozone

In certain respects, the US and eurozone monetary policies look similar: both the Federal Reserve (Fed) and European Central Bank (ECB) have dramatically expanded their balance sheets over the past five months.  That said, the Fed appears to have paused its QE program, perhaps encouraged by the extent to which equity and precious metals prices have risen (Figure 2).

Figure 2: The ECB and Fed rapidly expanded their balance sheets in Q2 but have since slowed down

When it comes to policy rates, however, the two central banks remain far apart.  In February and March, the Fed cut rates from the 1.75-2.00% range to 0-0.25%.  By contrast, the ECB last cut rates on September 12, 2019, going from -40 to -50 basis points.  It opted not to cut rates further into negative territory amid lockdowns in the first half of 2020.

Expectations were that negative rates would weaken EUR: after all, who would want to pay to  deposit EUR with the ECB?  That said, as we have often seen in Europe and elsewhere, negative rates did not prevent the currency from strengthening. 

EUR weakened on a trade-weighted basis after the ECB’s first cuts into negative territory in 2014 and 2015.  Following subsequent reductions to -30, -40 and -50bps, EUR strengthened each time (Figure 3). It may be that by taxing the banking system through negative deposit rates, the ECB is actually contracting rather than expanding money supply, leading investors to hoard cash.  Even before the pandemic struck, France, Germany and Italy were all showing zero or negative growth in Q4 2019.

Figure 3: EUR strengthened on a trade-weighted basis as the ECB cut rates below -20bps

In theory, with the Fed policy rates between zero and 25bps and the ECB’s at -50bps, the interest rate differential between USD and EUR should be 50-75bps.  In actuality, it appears to be closer to 60-100bps, judging by the difference between CME EURUSD futures and the EURUSD spot exchange rate (Figure 4).  Despite the interest rate premium that USD investors get over investors in EUR, USD has been weakening in recent months as EUR strengthened.

Figure 4: The interest rates differential between the US and Europe appears to be larger than the gap between central bank rates

The Pandemic

In addition to diverging fiscal and monetary policies between the US and Europe, there is one other  distinguishing factor: the course of the pandemic.  The coronavirus struck the eurozone sooner and harder, in March and April.  By early April nearly 12 of every 100,000 people in Europe had died as a result of COVID-19 in the previous two weeks.  The US mortality rate peaked later in April and was about 30% lower on a population-adjusted basis.  Since then, however, the European mortality rate has fallen to close to zero, while the US mortality rate fell to 2 out of every 100,000 by early July and then climbed to above four on a two-week rolling basis (Figure 5).

Figure 5: Europe’s COVID-19 fatalities fell to low levels during the summer while the US remained elevated

If one takes the US mortality rate and subtracts the European mortality rate, one can see some relationship between relative mortality and movements in EURUSD.  When Europe’s mortality rate was higher in March and April, EUR weakened.  As the US mortality rose relative to Europe’s in May and June, EUR recovered with a few weeks’ lag.  As the US mortality rate subsided in June, the dollar strengthened, only to see the euro surge again as the US mortality rate rose again in July while Europe’s rate remains close to zero. Investors may be looking at relative mortality rates to gauge the pace at which economies can reopen for business and the relative attractiveness of holding the two currencies.

Bottom Line

  • EURUSD hits its highest level in 27 months in August.
  • More active fiscal stimulus in Europe may be supporting EUR.
  • ECB’s negative-rate policy may also be propping up EUR.
  • US-Europe swap rate differential may be greater than the difference between central bank rates.
  • EURUSD has also tracked the relative mortality rates between the US and Europe as the course of the pandemic diverged over the spring and summer.


All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

About the Author

Erik Norland is Executive Director and Senior Economist of CME Group. He is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy, and upon those who trade in its various markets. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical conditions.

View more reports from Erik Norland, Executive Director and Senior Economist of CME Group.

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