Fundamental Evaluation Series: EUR/USD vs. 2-year yield spread

The chart above shows, how the relationship between EUR/USD and 2-year yield spread (U.S. - Eurozone) has unfolded since 2012. It is evident that these short rates have been a key influencing factor for the pair as policy divergence became evident since 2013.

The chart clearly shows the close relationship between the yield spread and the exchange rate. Since December 2013, the yield spread declined from -0.2 percent area to -3.56 percent area by November 2018, and EUR/USD declined from 1.38 to 1.13 area.

However, in our December review, we noted that since the second week of November, the yield spread has reversed course, and rose from -3.56 percent to -3.26 percent, which suggested that there might be a reversal in the exchange rate going ahead, should the spread continue its reversal.

As expected the exchange rate has reversed course and euro rose against the USD. However, as the yield spread continues in consolidation between -320 bps to -304 bps, the euro is consolidating between 1.12-1.16 area.