The EUR/USD is the most popular currency pair in the world because of the size and stability of the United States and the European Union. The two blocs have a combined Gross Domestic Product (GDP) of more than $36 trillion, equivalent to more than 40% of the global economy. They are also relatively stable and have an above-average credit rating from all the popular credit rating agencies.
The two sides are also some of the biggest trade partners in the world. According to the US Trade Representative Office, the two sides make annual trade worth more than $1.1 trillion. Of this, the US sells goods and services worth more than $468 billion.
In this article, we will look at how to conduct a good fundamental analysis of the EUR/USD pair.
What is fundamental analysis?
Fundamental analysis refers to the study of key economic data and news events that move currency pairs and other assets. The strategy differs from the other popular types of analysis like price action and technical analysis.
Price action is the process of looking at charts and conducting an analysis based on several patterns like triangles, pennants, flags, and head and shoulders. Technical analysis, on the other hand, is the process of using chart patterns in combination with technical indicators like Moving Averages and the Parabolic SAR.
Many traders use a combination of these three strategies to analyze currency pairs. Others use each of them individually. For example, there are global macro traders who specialize in fundamental analysis processes.
The Fed and the ECB
The best starting point to conduct fundamental analysis on the EUR/USD pair is to know more about the Federal Reserve and the European Central Bank. These are independent institutions that control the monetary policy of the two sides.
Their mandates are usually similar. In normal periods, the two central banks hold monetary policy meetings eight times per year. In these meetings, they deliberate the current economic trends and adjust policies in order to promote employment and stabilize prices.
Two of their most important tools are interest rates and quantitative easing (QE). The banks lower interest rates when the economy is not doing well, and vice versa. They also implement QE in periods of high uncertainty, such as during the coronavirus pandemic and the 2008/9 financial crisis.
For starters, QE is a process where the central bank prints money and buys relatively stable financial assets like mortgage-backed securities (MBS) and Treasuries. By doing so, they increase the amount of liquidity in the market and lower the cost of borrowing.
At the time of writing, the Fed and ECB had balance sheets worth more than $7.9 trillion and $7.6 trillion, respectively.
Top European and American economic data
In fundamental analysis, investors and traders use the economic calendar to anticipate what the two sides will release. Indeed, the EU and US statistics agencies are some of the most active in the world.
Here are the top economic numbers that move the EUR/USD pair.
Non-farm employment data
The US Bureau of Labor Statistics (BLS) releases the non-farm payroll numbers every first Friday of the month. The goal is to inform investors and policymakers about the state of the labor market.
The report has several important numbers like the unemployment rate, wages, and participation rate. It also breaks down how the various sectors of the economy added or lost jobs. The NFP data is usually one of the top movers of the EUR/USD pair.
The Eurozone also releases its job numbers every month through Eurostat. While these numbers are important gauges of the state of the European economy, they tend not to have a major impact on the EUR/USD. This is partly because the EU economy is made up of several countries that have a different economic mix.
Inflation
Inflation is an important economic metric that refers to the changes in prices of several items like food and energy products. Inflation and unemployment rate are the two popular figures that the Federal Reserve and the ECB pay close attention to when making interest rate decisions.
Ideally, they raise interest rates when inflation rises and cut when it falls. The US and EU publish several inflation gauges like the Consumer Price Index (CPI), Producer Price Index (PPI), and Personal Consumption Expenditures Index (PCE) every month.
Manufacturing and services PMIs
The manufacturing and services PMI numbers are important measures of the performance of an economy. They are usually compiled by surveying companies in the sector and weighing different gauges. In the US and EU, the data is compiled by Markit, which is a large data provider.
The Institute of Supply Managers (ISM) also publishes the data from the United States. These numbers have some modest impact on the EUR/USD when they come out.
Retail sales
The retail sector is a critical gauge of the performance of the EU and the American economies since household consumption is the biggest part of their economies. These numbers are published every month.
Other important economic data when trading the EUR/USD pair are the housing starts and building permits, industrial production, and GDP data.
Geopolitics
The EUR/USD is also affected by geopolitics. In most cases, the pair drops when there are substantial risks to the global economy because the US dollar is usually viewed as a safe haven.
Indeed, the pair declined sharply when the coronavirus was declared a global pandemic. It then bounced back after the Federal Reserve started to slash interest rates.
Final thoughts
The EUR/USD is the most popular currency pair in the market because of its deep liquidity and low spreads. It is also offered by the most popular forex brokers. In this article, we have looked at some of the top factors that move it and how to conduct fundamental analysis on them.
