We can link the maturity-dependent interest-rate gaps back to the movement of the EUR by using the forward rate ratio (FRR). This measure is constructed by taking the forward rate between six and nine months — the rate at which you can lock in borrowing for three months starting six months from now, and dividing it by the nine-month rate. The more this ratio exceeds 1.00, the looser monetary policy is expected to be. Critically, these forward-rate ratios are comparable across economies and across interest rate levels.
We can compare these FRRs of the USD and EUR to the three-month yield spread. While the USD’s FRR had been consistently higher (steeper yield curve) than its EUR counterpart since mid-2001, this relationship has reversed. For the first time since 2000, a period of great weakness for the EUR, the USD’s FRR exceeds that of the EUR. This is dollarbullish: It is not the absolute interestrate differential that is critical for an exchange rate’s movements, but rather the relative monetary policy expectations as measured by the shapes of the two money-market curves.
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