Euro-Dollar Gets No Joy from Manufacturing's Green Shoots as Yields and Safe-havens Win

- EUR underperforms with yields and safe-havens in demand.

- Even after more green shoots in manufacturing for January.

- Charts points to a EUR dip below 1.10 says Commerzbank.

- EUR correlation with China's sickly CNY also said to be rising.

- Lack of yield, stand-pat ECB also weigh around ankles of EUR.

- Continued global economic recovery key to EUR/USD outlook.

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The Euro-Dollar rate declined as the single currency ceded ground to all major rivals Friday even after IHS Markit PMI surveys revealed further signs of 'greenshoots' in the German manufacturing sector, as investors appeared chase anything other than European currencies.

Green shoots of recovery continued to sprout from the grounds of key-but-troubled Eurozone manufacturing sectors this January, according to the latest flash IHS Markit PMI surveys, which showed activity in the continent's industrial heartlands surprising on the upside. 

Europe's flash manufacturing PMI rose from an upwardly-revised 46.3 to 47.8 in January when markets were looking for an increase to only 46.9, although the barometer remains below the 50.0 level that separates industry expansion from contraction. Gains were led by both German and French factory sectors.

The services PMI actually fell from an upwardly-revised 52.8 to 52.2 in January when markets were looking for an increase to 52.9. But that particular barometer has not dipped below 50.0 at any point in the near-two-year Eurozone economic slowdown and has been rising steadily since October. 

However, and on the downside, declines in services and weakness in some other parts of Europe led the overall 'composite PMI' to remain unchanged at 50.9 in January when markets had looked for an increase to 51.2.

Above: Euro-to-Dollar rate shown at hourly intervals.

"Growth remains concentrated in services, but the pace eased at the start of the year, at the same time as activity in manufacturing showed evidence of stabilisation. The slow pace of output growth fits with the picture in the new orders data," says Claus Vistesen, chief Eurozone economist at Pantheon Macroeconomics. "Expectations for the year as a whole are now shooting higher, thanks primarily to a rapid improvement in manufacturing."

PMI surveys measure changes in industry activity by asking respondents to rate conditions for new orders, production, hiring intentions, prices and inventories. A number above 50.0 indicates industry expansion while a number below 50 is suggestive of contraction. The survey results often correlate with official measures of output, although they can often be wide of the mark too.

The Euro was quoted lower against all major currencies other than smaller continental rivals Friday as investors appeared to cling to safe-haven positions from earlier this week amid ongoing concerns over the spread of China's coronavirus, while also bidding for yields of the U.S. and Canadian Dollars. 

"EUR/USD has eroded the 3 month uptrend. The intraday Elliott wave signals remain slightly negative and this leaves attention on the downside to initially the 1.0981 29^th November low. More importantly it has neutralised our bullish bias and forced us once again to the side-lines," says Karen Jones, head of technical analysis for currencies, commodities and bonds at Commerzbank.

Above: Euro-to-Dollar rate shown at daily intervals.

Friday's Euro-to-Dollar rate was 1.1033, down 0.19% for the session while the EUR/GBP and Pound-to-Euro rates were trading close to their breakeven levels throughout the morning. Pound Sterling was softening against most rivals ahead of an anticipated rate cut from the Bank of England (BoE) next week.

The Euro was lower against the Yen, Swiss Franc and the whole Dollar bloc but higher against the Norwegian Krone, Swedish Krona and Polish Zloty. 

The Dollar was higher against all major rivals other than the Kiwi and Australian Dollars early during the morning session although its gain over the safe-haven yen was just 0.01%. The Aussie was the morning's best performer while the Kiwi was a close second as markets priced-out the possibility of near-term rate cuts.

"Incoming information about the speed and spread of the virus will have to show whether current containment measures are sufficient. Assessing the economic damage at this stage is extremely difficult and highly speculative, but what many investors may now be asking themselves is whether this external shock can nip the ‘green shoots of recovery’ in global trade and production [emerging] since 2019Q4, in the bud," says Elwin de Groot, head of macro strategy at Rabobank. "The key question now is whether this pickup in global activity will last or will turn out to be a short-lived recovery. Our view is that it will be the latter.”

Above: Euro performance against major rivals Friday.

Friday's data comes after the European Central Bank (ECB) announced during the prior session the formal launch of a strategic review of its policy stance and general way in which the Governing Council does business. It left the post-September 2019 deposit rate of -0.50% unchanged and confirmed a second €20bn purchase of bonds under its quantitative easing program. 

"2020 survey data seem to confirm an improvement in activity around the turn of the year, although the services sector may still be slowing down in a number of countries as it works off the earlier negative shocks in the industrial sector. To some extent, that was also the conclusion from an analysis of the recent Eurozone credit data by ECB President Lagarde yesterday," de Groot says.

ECB President Christine Lagarde said during a panel discussion in Davos, Switzerland Friday that the recent upward move in Eurozone inflation has been "really minor" before noting the bank is yet to observe any transmission from recent wage growth into consumer prices - underlining the ECB and Euro's ongoing dilemma. It's been a long time since the bank met its "close to but below 2%" inflation target although most recently the target has been scuppered by a seemingly-easing economic slowdown. 

"While the economic downturn is taking time to bottom out, the Eurozone PMIs add to recent data that suggest the worst will soon be over," says Holger Schmieding, chief economist at Berenberg. "The downturn in manufacturing, which has been the key reason for the overall slowdown in Eurozone growth last year, is easing. Despite still registering falling activity, the subindex for manufacturing has now edged up in three out of the last four months."

Above: Berenberg graph illustrating relationship between IHS Markit composite PMI and Eurozone GDP growth.

President Donald Trump's October 11 'phase one deal' to end the trade war with China was only signed this month although the earlier announcement has been lifting confidence in the global manufacturing sector for months now. But the rub for the Euro is that even if the global and Eurozone economies were to gather steam in 2020, the ECB's newly-launched strategic review all suggests the bank will not even think about adapting its policy stance for a while yet. 

The ECB says it expects the review to conclude around year-end. Many observers expect it to result in interest rates being kept at or near to current levels for years to come, and for it to also insert the bank into the climate debate and policy process.But other than that and the obvious, the only thing that can be said for certain in relation to it is that the pending period of reflection may prevent the ECB from changing its policy stance absent an economic shock that necessitates additional Euro-negative stimulus.

Some have a different view though. Economists at BofA Global Research said Friday that if sentiment continues to improve and signs of growth bottoming out are confirmed in GDP numbers then the ECB's policy stance could change quicker than the market expects. And such a shift would be made all the more likely if core inflation further extends a recent run of gains from 0.9% in July 2019 to 1.3% by November. Core CPI has held at 1.3% since then. 

"The market reaction to the ECB surprises us. We did not perceive this as a dovish meeting. Granted, the move is subtle, and the speed is slow. But the risk balance is moving and the ongoing strategic review does not mean policy is on freeze. The next few data points will be crucial," says Ruben Segura-Cayuela, an economist at BofA Global Research. "We think the debate around the ECB's risk assessment shifting to neutral could gain traction."