All of these countries share the Euro as a common currency, except for Denmark, Sweden and the United Kingdom. They are known as the European Monetary Union (EMU). Aside from a common currency, these countries also share a single monetary policy dictated by the European Central Bank or (ECB).

The EMU Today
The EMU is the world's second largest economic power, with GDP valued at over US$6Trl in 2002. With a highly developed fixed income, equity and futures market, the EMU has the second most attractive investment market for domestic and international investors. The EMU is primarily a service-oriented economy. Services in 2001 accounted for approximately 70% of GDP, while manufacturing, mining and utilities only account for 22% of GDP.

The EMU is both a trade and capital flow driven economy, and it has emerged as the most legitimate competition for the US in terms of capital investments. German bonds are a major alternative to US Treasuries. Unlike most major economies, the EMU does not have a large trade deficit or surplus. In fact, the EMU went from a small trade deficit in 2001 to a small trade surplus in 2002. EU exports comprise approximately 19% of world trade, while EU imports account for under 20% of total world imports. Because of the size of the EMU's trade with the rest of the world, it has significant power in the international trade arena. International clout is one of the primary goals in the formation of the EU, because it allows the individual countries to group as one entity and negotiate on an equal playing field with the US, who is their largest trading partner.

The Future of the EUR
The EU's growing role in international investment and trade has important implications for the role of the Euro as a reserve currency. It is important for countries to have large amount of reserve currencies to reduce exchange risk and transaction costs. Traditionally, most international transactions involve the British Pound, the Japanese Yen, and/or the US Dollar. Before the establishment of the Euro, it was unreasonable to hold large amounts of every individual EU national currency. As a result, currency reserves tended toward the dollar. At the end of the 1990s, approximately 65% of all world reserves were held in US dollars, but with the introduction of the euro, foreign reserve assets are shifting in favor of the euro. This trend is expected to continue, as the EU becomes one of the major trading partners for most countries around the world. More importantly, the EU has emerged as a place to invest in both bonds and equities.

Economic Indicators for EUR
GDP for Germany, France, Italy
Germany is the largest economy in Europe, and German economic data moves the EUR price more than any other nation’s economic releases. French and Italian GDP is less important than German data, but it is still relevant to the EUR. GDP is the central measure of economic growth in a nation, and if the GDP of a given country exceeds or fails to meet expectations by a significant amount, it can move the market. Because German data is more heavily weighted than French or Italian, a small difference between German expectations and releases would have the same effect as a much larger gap in French or Italian data.

Unemployment
Because of the political environment in Europe, unemployment data is an even more important indicator than it is in most other nations. Organized labor is politically more powerful in Europe than it is in the US, and Europe is much more sensitive to changes in employment. German, French, and Italian unemployment data can affect the level of the EUR, aside from having political implications as well. Unlike unemployment in the US, which gains attention mainly around elections, unemployment in Europe is an important indicator at all times.

Ten Year German Bund
German ten year bonds are the closest equivalent to the US 10 Year Treasury, and the difference in these 10 year rates can be an indication of where capital investments are likely to go as investors seek the highest return. This in turn will drive up the value of the currency in which the bonds are held.

Money Supply (M3)
One of the mandates of the ECB is to maintain low inflation, and one of the tools it uses is control of the money supply. In order to maintain a target inflation rate of 2%, the ECB looks for an increase of roughly 4.5% in M3. If M3 is much higher than expected, it can be a sign that inflation is increasing and that a rate hike might be coming. Inflation is of much greater concern in Europe than it is in the US, and it usually comes much earlier in the economic cycle. This means that the ECB is more likely to aggressively raise interest rates than the FOMC, and the market may react to early signs of rate hikes.

Trading EUR
The Euro has emerged as a competitor to the dollar as a destination of foreign investment, and because the Eurozone is a major trading partner with many other countries, most crosses in EUR have high trading volume. EURUSD is the most heavily traded currency pair, while EURCHF and EURGBP have emerged as the dominant crosses for both CHF and the GBP.


EURUSD

• Most heavily traded of all currency pairs, which typically with the narrowest spread on the interbank market as buyers and sellers compete over the inside market.
• Most active beginning 8:00 GMT (3 am EST) at the beginning of London trading hours. London is the dominant FX market in the world, especially for EUR, CHF and GBP pairs.
• Often has little activity after the middle of the US session (roughly 1700 GMT).
• Follows technical analysis extremely well, and is well suited to breakout or trend trades. The pair is poorly suited to range trades most of the time because of the large number of speculative traders.
• Follows movement in capital markets: bond markets or equities, depending on which is most active at the time. When equities are experiencing a strong bull market, the S&P 500 can act as a leading indicator for USD strength against the Euro. When bond markets are dominant, the difference in yields on a 10 year German Bund and the US 10 year Treasury can identify movement of capital in the pair.
• Open interest on the Euro Futures market on the Chicago Mercantile Exchange can be used as a rough indicator of market interest and positioning, although it is not a perfect volume indicator.
• Reacts to data out of a variety of countries, sometimes focusing heavily on US releases, other times focusing on data out of Germany, France, and Italy.
• Because it trades more often in trends than in a range, indicators like moving averages or crossovers are more often useful than Bollinger bands or RSI.

Note:

Jimmy Young is a seasoned institutional forex trader having 20 years of experience with different banks. He headed up bank FX dealing rooms. He is FX profitability consultant to major European private bank. He manages funds and also trades personal money. Between 1981 and 2004 he was a foreign exchange trader at following banks: Societe Generale, Julius Baer, Fuji Bank, Indosuez, Erste, Hill Samuel, Manufactures  Hanover, Paribas, European American. www.EurUsdTrader.com