The Euro-Dollar Rate is Tipped as a "Sell" after Trade War Threatens to Morph into a Currency War

© European Central Bank, reproduced under CC licensing

- Trade war and risk of currency conflict threaten global economy.

- EUR sensitive to global growth pulse, being sold at TD Securities.

- But others cautious, mindful that China's CNY may push EUR higher.

The Euro reversed its earlier course and drifted lower on Tuesday as the Dollar rebounded from its previous slump but the exchange rate is still being tipped as a sell by strategists at TD Securities, who say the single currency is likely to suffer as fears for the global economy rise. 

Europe's unified unit is sensitive to changes in the pulse of the global economy, which is now seen as likely to slow further in the months ahead as the trade conflict between the U.S. and China escalates. The U.S. said last week it will impose fresh tariffs on imports from China as of September 01. 

This risks hurting an already-weakened Eurozone economy, which grew by just 0.2% during the second quarter and is forecast by the European Commission to grow just 1.2% for overall, which implies a fall from last year's 1.8%. Eurozone GDP growth slowed sharply in 2018 too, from 2.3% previously. 

"Growth rather than rate differentials have been an essential driver of the EUR since the start of the trade wars," says Mark McCormick, head of FX strategy at TD Securities. "Germany remains the most vulnerable to a pullback of Chinese growth, and the escalation of the trade wars could inject a risk premium on the EUR. Positioning rather than anything fundamental has supported the short-term bounce in the EUR."

Above: TD Securities estimates of G10 currency valuations. 

The Euro's increased correlation with the transatlantic growth gap, rather than interest rate spread, is bad news for the single currency because the U.S. economy is expanding much faster than the Eurozone. GDP growth was an annualised 2.1% in the second-quarter, almost twice the 1.1% seen in the Eurozone. 

And political developments on distant shores suggest the Eurozone economy is set to continue slowing, which is negative for the Euro even if the U.S. is also expected to decelerate too. McCormick made betting on a fall in the Euro-to-Dollar the trade-of-the-week (TOTW) recommended to TD Securities clients.

This is after the Euro received a notable boost during the Monday session, as the Dollar sank against many major rivals in response to speculation suggesting the tariff fight between the U.S. and China might be on the verge of turning into a currency conflict. 

"Other factors driving the FX market don't argue for tactical long EUR exposure either. Our tracking of growth momentum remains tepid, and European equities continue to lag the US. The forward-looking implications of Trump's recent actions should reinforce these themes rather than reverse them. The other lingering concern is whether Trump will pivot to autos this fall, which is likely to contain rallies in the EUR in the interim," McCormick says. 

Above: Euro-to-Dollar rate shown at 4-hour intervals alongside USD/CNH rate (yellow line, left axis).

Markets feared a currency war Monday after the USD/CNH rate rose above the psychologically important 7.0 level following the daily 'fixing' of the onshore USD/CNY rate by People's Bank of China (PBOC). The PBOC sets a midpoint level that the exchange rate is able to deviate above and below by a margin of 2% on either side.

That midpoint was set at 6.9220 Monday when markets were looking for a rate below 6.90, leading analysts and investors to assume the PBOC was about to let the rate rise in order to offset the tariffs announced by the U.S. the previous week, which would have been sure to draw the ire of President Donald Trump. A weaker Chinese currency would make imports cheaper for Americans to buy and would offset the tariffs if the Renminbi falls far enough.

President Trump says he will impose a 10% tariff from September 01 on the remaining $300 bn of goods the U.S. imports from China each year, which means all of its U.S.-bound exports will then be covered by some form of tariff. Trump has repeatedly threatened a tariff of 25% for all of China's trade with the U.S. and there's now $250 bn of it covered by a levy of that size.

"The Trump administration is seeking mutually incompatible outcomes where the focus lies in stealing growth from the ROW but seeking to limit the natural shock absorbers that cushion these blows to the global economy. Higher US stocks and a stronger USD simply can't cohabitate and a weaker global economy fuels a stronger USD," McCormick says. "We sell EURUSD at 1.119, targeting a move to 1.101."

Above: Euro-to-Dollar rate shown at daily intervals alongside USD/CNH rate (yellow line, left axis).

This week's move in the USD/CNY rate took the Euro-to-Dollar rate with it this week when on both the occasions the White House previously announced large tariff measures against China, the two exchange rates diverged, with the Renminbi and China-sensitive Euro both falling at the same time. China is a significant market for Europe's factory sector, which has fallen into recession since the trade war began in the second quarter of 2018.

Some analysts say Monday's response from the single currency and the possibility of further weakness in the Renminbi mean the risks for the Euro-to-Dollar this week are both to the up as well as downside. In other words, it might not be a good idea to bet in either direction on that exchange rate, even if the Eurozone's fundamentals do argue for a lower Euro. 

"Apart from the medium-term view that USDRMB is a "buy on dips", our short-term assumption is that USDCNH will trade in a 7.05/7.15 range for the time being, which effectively means we've assumed a "risk-neutral-to-risk-off" profile (i.e. there is more USDRMB topside in that range than downside). Until we can say that this phase of the trade war has "settled down", it's tough to take a firm position in EURUSD spot; it could go either way," writes Stephen Gallo, European head of FX strategy at BMO Capital Markets, in a note to clients. 

Time to move your money? Get 3-5% more currency than your bank would offer by using the services of foreign exchange specialists at RationalFX. A specialist broker can deliver you an exchange rate closer to the real market rate, thereby saving you substantial quantities of currency. Find out more here.

* Advertisement