Market Overview

14 February 2020

What's Pressuring the Euro, and How Serious is This?

European stocks extended a rally, with a pan-European STOXX 600 index breaking a fresh all-time high at 430 points on Friday, French CAC 40 and German Xetra DAX indexes are performing the same again near 6100 and 13750 point levels, respectively.

At the same time, the single European currency was pinned down to its lowest levels vs the US Dollar since April 2017, as EUR/USD traded near 1.0825 today and EUR/GBP was moving towards a plausible break down of the three-year 0.8275 technical support.

This paradox reflects a rather strange but excusable attitude of a huge number of global investors to European assets. They are inclined to believe in a growing capitalisation of major European companies, with a hope for strong revenues and good dividends. But the same people do not see any tangible returns from European bonds with their negative, or close to zero, coupon yields.

German bonds, with -0.4% negative yield in Euro, are indolently attracting investors, while even the US 10-year Treasury Notes historically low yields at their present 1.6% level of the guaranteed annual yield in US Dollars are attracting much more attention. It is rather easy to understand why most investors are not preferring the Euro.

It is a very different story with European shares as investments in the stock markets do not provide any guaranteed close to zero income but the "blue chips" and other companies' shares warm-up interest with a possible high income, despite sometimes even bigger risk of losses. Shares are globally in the uptrend due an extremely dovish monetary policy of the European Central Bank (ECB), the US Federal Reserve (Fed) and the Bank of Japan (BoJ) that supply banks and funds with trillions of Dollars, Euros and Yens through the cheap credit lines and via special long-term asset buying programs (quantitative easing).

Therefore, stock market investors are paying much less attention to the macroeconomic indicators of the countries, while the government bond traders and currency traders are traditionally looking more carefully at the latest economic statistics from the Eurozone. However, most of the European economic indicators are disappointing so far.

The resent Germany's Gross Domestic Product (GDP) figures for Q4 are at 0.0% (zero) level after +0.2 in Q3. The Eurozone GDP is at +0.1% in Q4 and only 0.9% year-on-year which is rather frustrating. Recent industrial production data showed a sharp tumble of -2.1% in December, 2019. If compared with a +2.1% of GDP growth in the United States, it could be believed that the United States is stronger than Europe in trade frontiers so far. The US inflation found a "sweet spot" in January with 2.5% year-on-year growth in the Consumer Price Index (CPI), which is already growing for the fourth consecutive month.

All this reduces the chances of the US interest rates cut over the next six months, while the interest rates in Europe are still in a negative zone and ECB defends the need for low rates and monetary stimulus. Although markets may not "discount" the idea that the whole situation may change before the end of 2020. ECB's president Christine Lagarde this week said, the side effects of policy become greater with time, and she emphasised: "The longer our accommodative measures remain in place, the greater the risk that side effects will become more pronounced". She also added: "When interest rates are low, fiscal policy can be highly effective, monetary policy cannot and should not, be the only game in town". As for the inflation in dynamics, she admitted that it remains some distance below the ECB medium-term aim of "some fellow 2%", but at the same time wages increase at an average rate of 2.5% in the first three quarters of 2019, significantly above their long-term average line.

Taking all these indications into consideration, it may be thought that this could be a hint to the European governments that they should act quickly in order to support the economic expansion now because the ECB simulative monetary police could have its time limitations. Mrs Lagarde has already said that a review of the entire set of measures currently applied will probably be completed by the end of 2020. This deadline may give some reasons to expect that. Even with a slight improvement in Eurozone economic indicators, the ECB could return an interest rate to zero levels for the beginning of 2021, with a prospect of a possible 0.25-0.5% target level some time later. Not all the Eurozone economic indicators are weak: the Euro area unemployment is at 7.4%, a percentage that is at its lowest level since May 2008.

With these considerations in mind, the market participants may restrain their mood for a relatively cheaper Euro exchange rate, and therefore EUR/USD may be expected to rebound higher off the 1.0750-1.0850 technical support area with an opportunity to recover to 1.1050-1.11 area as a baseline scenario. A similar pattern of gradual return to more moderate price levels was observed for the Euro last year, each time the European currency fell to new annual 2019 lows. However, the overall pressure on the Euro is likely to remain so over the next several months at least, so that the breakout to 2016 levels around 1.05 is still a real threat, even in a short-term perspective.


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