It has been the perfect storm for the EUR in the last 4-5 months. Having reached highs a little over 1.2500 vs the USD at the start of the year, we finally saw a little relief here as market participants started to rein in their fears over the budget and trade deficits in the US – which for the record, are still rising and widening as nominal yields continue to head north. Back to the EUR and Eurozone specifically, the move back to 1.2000 would have come as a welcome relief to the ECB, having sat nervously, watching their currency leap from high to high as a function of momentum and mass euphoria over the turnaround in growth. And how that has ended! Not that we were not given signals of caution – (I say us, I mean the market). During the ECB press conferences in late 2017, projections on growth and inflation were based on a EUR/USD level of 1.1800, though at the time we had already pushed through 1.2000, with the market chomping at the bit to extend the bullish view on the EUR – and in tandem deficit fears on the USD – to its limits. This naturally had consequences and the results have materialised, but only after a prolonged period of jostling at the highs despite going against yield differentials. The fact that we are now trading on the self-same yield differentials to a higher degree – 10-30yr Treasuries some 50-100bps higher and ECB normalisation pushed further out on the horizon – shows just how sentiment can change.
At this point, everyone will be pointing to the level of economic weakness, which has been exacerbated by the protectionist policies of the current US administration, and its influence on the soft data in Germany and the rest of the exporting nations in Europe has been clear to see.
Then we come to the fears over Italy’s debt ratio and its potential blowout stoked by the budget plans of its populist government, and we have a game, set and match scenario which has all but consigned the single currency to the sidelines – and I am being polite here. Gone are the notions that we can consider the EUR a safe haven as we have in previous episodes, as the momentum in sentiment is that we are potentially moving to all out fears of an existential crisis. Are we? Based on much on all the dirty laundry being aired by the EU (and Italy), it is not hard to see why investors are shying away from Europe at the present time, though at this stage it is hard to discern just how much is down to a possible implosion of Italy and/or the lack of flexibility by the EU hierarchy. Current accounts have been a key determinant of exchange rate bias, but politics wins hands down at the moment, so we can discard that one for now despite this being in favour of the EUR and JPY. Convenience plays its part here, yet when measured alongside that of fair value based on purchasing power parity, there is a positive backdrop (no matter how remote at this stage) against which the EUR can lean on – eventually.
Consequently, constructive trade talks with the US will or should have a positive impact on EUR/USD going forward. From a technical perspective, everything is pointing to a test towards 1.1000 from here, though timing will be key as ever. Liquidity – or the lack of – has played its part in removing support points on the way down, with 1.1500 and 1.1300 both needing a series of tests to eventually break through. There has been anecdotal evidence of central bank demand at these levels – PBoC and SNB likely – though banks have seen little interest from domestic exporters ready to lock in much-improved rates, so this will likely be reinforced by any developments in the initial point made in this paragraph.
In conclusion, there is little to feel optimistic about the EUR at the moment, other than the fact that in the crosses, we have seen a relatively tame response to the data and political uncertainty in comparative terms. With the USD on the front foot and effectively winning out in all scenarios – whether it’s risk on or off – but just as we noted with the impulsive EUR rally into the start of the year, we expect the same dynamics to play out in the US, which will also see the effects of the tax cuts passing through, if they haven’t already.