The Euro and the British Pound used to be like close cousins… whenever one went up the other followed suit and vice versa. Even the volatility and size of the movements were about the same – with the GBP acting just a little more volatile. The correlation of EUR to GBP was 1 to 1.1/2, meaning that if EUR/USD moved 100 pips up, GBP/USD would move about 120 pips up. But in the last few months, and particularly in the recent weeks, we have seen them diverge and turn into negative correlation currencies. So, what´s happening… what has changed?
The Euro has changed its behaviour
Well, not much has changed for the GBP because it has remained a ‘risk’ currency. These changes are accounted for in the Euro. The Euro used to be a risk currency together with the GBP and the commodity dollars. But now, we see that whenever there´s risk appetite EUR/USD goes south and whenever the traders feel there´s danger in sight EUR/USD goes to bid. So it basically has turned into a safe haven just like the Yen and the CHF. There are three reasons for that:
Since the ECB has the lowest rates among the big central banks, a lot of Euros have been used during the last years to fund trades or investments with high risk, so whenever there is risk aversion these trades are closed and demand for the Euro and EUR/USD goes up.
The consensus in the market is that global uncertainties will likely affect the FED more than the ECB, meaning that the FED will delay the rate hikes. But the ECB won´t ease further if things get worse. As a result, EUR/USD goes up when there is trouble in the financial world.
Since the US and the UK have been the first to unbury themselves from the 2008 crises, plenty of money has been invested in risky assets in these two countries. So, when there is trouble these assets are sold which results in the Euro going up against the USD and GBP.