International economics textbooks have always taught students that currency exchange rates depend, among many other things, on the monetary policy stance by central banks. A famous rule of the thumb in the International Economics, has always explained that expansionary monetary policies, consisting of cutting interest rates or increasing the money supply (or a mix of the two measures), produce always a devaluation of the domestic currency, because the advantage of holding it decreases compared to the yield offered by financial assets denominated in other currencies.
Otherwise, restrictive monetary policies make domestic currency-denominated assets more attractive to investors and this entails an appreciation of the domestic currency against the other currencies.
In the financial and economic crisis we are experiencing, the Fed and the European Central Bank have undertaken exceptional, unprecedented monetary policies, lowering rates to zero (in the US) or below zero (in the Eurozone) and initiating direct (in the US) or indirect (in the Eurozone) debt monetization policies on an unprecedented scale. Money printing has reached a trillion-dollar size.
From this unprecedented injection of fresh money we would have expected, according to the macroeconomic theory, a euro-dollar exchange rate of a volatility never seen before. Instead, the euro-dollar exchange rate remained unchanged, fluctuating in the trading range 1.08 – 1.10 since the beginning of the crisis. This evidence represents a great challenge, if not a defeat, for the traditional international macroeconomic theory, whose assumptions seem to have failed.
What is the reason why the euro-dollar exchange rate kept steady within the trading range 1.08-1-10? The answer may be found in the tremendous uncertainty surrounding the global economies due to the crisis. Very few economists felt sure to depict future scenarios, and the forecasts made by the most important forecasters differed a lot among them. Who could tell which one between the Eurozone and the US economy would have performed better or worse? Or by how much would the two GDPs, or jobless rates, have shrunk? Nobody. And since big traders knew it, they preferred not to bet on a specific EURUSD market direction. They weren’t looking at the current stances of central banks but at the future uncertainty instead. A brief but effective lesson for traders who wish to understand how to trade big pairs in very uncertain times. Sometimes the best thing to do is stay exactly where you are.