Euro-to-Dollar Week Ahead: Shining Brightly as Ashes of Global Inferno Smoulder

- EUR/USD sees largest weekly gain since early July 2017.

- As risk appetite evapourates, with more instability ahead.

- EUR/USD rate tipped for more gains by multiple analysts.

- Charts point higher as EM, equity weakness lifts the EUR.

- EUR benefits from liquidation of 'carry' trades in EM world.

- Virus outbreak grows in U.S., UK Italy, elsewhere in Europe.

- EUR CPI and retail sales data in the shade amid virus fears.

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- EUR/USD Spot rate: 1.1024 +1.78% last week

- Indicative bank rates for transfers: 1.0642-1.0719

- Transfer specialist indicative rates: 1.0863-1.0929 >> Find Out More About This Rate

The Euro rate scored its largest gain over the Dollar since early July 2017 last week stock markets fell apart and emerging market currencies crumbled but given the live possibility of more instability over the coming days, the Euro-to-Dollar rate is tipped by multiple analysts for more outperformance. 

Europe’s unified unit outperformed amid turmoil for stocks and commodities as well as the currencies that underwrite them. So large were the losses for stock markets that in ordinary times they might now be due at least a short stabilisation but this week,respite could be short-lived for risk assets and the Euro-to-Dollar rate may retain an upside bias as a result.

Market prices will reflect an average of possible outcomes for any given situation at any given time and the boon for the Euro is that in the rapidly evolving coronavirus situation the worst case scenario could be significant enough to mean the appropriate average for risk assets is skewed a way below where valuations were, and possible even where they are sitting.

That can only be good news for a Euro that’s recently reaped the rare rewards of its ‘funding currency’ status.

“Directly above here lies the 1.1099 200 day moving-average, the 1.1138 55 week ma, the 1.1188 one year down channel and the 1.1240 recent high. These remain the break up point to the 200 week ma at 1.1347,” says Karen Jones, head of technical analysis for currencies, commodities and bonds at Commerzbank. “Dips will find initial support at 1.0879 the October low, but key support remains the 20 year uptrend at 1.0763.”

Above: Euro-to-Dollar rate shown at daily intervals alongside US/ZAR rate (orange line).

Commerzbank’s Jones has been betting on an increase in the Euro-to-Dollar rate since it was trading at 1.0785 and is targeting a move up to 1.1075 over the coming days at which point she intends to exit the position. She says the Euro is likely to find support around 1.0925 on an intraday basis. 

Europe’s single currency saw its biggest gains over the Dollar last week since August 2019 when China sent its Yuan falling to a decade-low, prompting steep losses for other emerging market currencies in the process, as stock markets and developing world currencies crumbled in the face of a rapid spread of coronavirus outside of China.

The virus has crept its way further into Italy, France and a number of other European Union countries while also making a first unexplained appearance in the U.S., UK and some other parts of the world. So far enforced quarantine measures have only been seen in Italy but the idea that such disruptive restrictions may soon be seen in the world’s most developed economies, and hubs of global finance, can no longer be deemed far-fetched.

“After such a pronounced correction lower in equity markets, it is very unlikely that this bout of risk aversion will reverse quickly,” says Lee Hardman, a currency analyst at MUFG. “Position liquidation could have much more to run. The euro could be the surprise beneficiary here. Substantial outflows included in the ‘other investment’ outflow in BoP data indicates large use of the euro as a funding currency. Expect JPY, CHF and EUR to continue to benefit in these financial market conditions.”

Above: Euro-to-Dollar rate shown at daily intervals alongside Down Jones Industrial Average (black line).

"I have seen the argument that Europe (and the US) will be less capable of (or even willing to) restricting people’s movement than China, thereby being less effective in limiting the spreading of the virus. Personally, I’m doubtful because, while it may be true that liberal democracies can take less draconian measures in these circumstances, we also “benefit” from a free press, which – so far – seems to be spreading more fear than facts," says Eric Nielsen, group chief economist at UniCredit Bank. "My point is that very little of the decline in travel in Europe right now is due to restrictions, but rather to self-imposed risk-reduction measures, often by employers."

The Italian government had declared 1128 cases of coronavirus as of Saturday, with close to a thousand in the Lombardy, Veneto and Emilia-Romagna regions. 

Eleven towns are under “lockdown” with nobody able to enter or leave affected areas and that government has now legislated to suspend payment deadlines for all debts to local authorities in the affected areas and provided for a stipend to workers in those areas for at least the next three months. 

“Investors had begun the year taking on risk in various forms, equities, emerging markets, carry-trades, and short volatility.  Many expected that the long-term decline in interest rates was over,” says March Chandler, managing director at Bannockburn Global Forex. “The slide spurred more sales by other market participants, including passive investors. The change in expectations of overnight money accounts for the bulk of the 77 and 71 bp decline in the 10-year and 30-year yields, respectively."

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

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The Euro: What to Watch 

The Euro outperformed all major currencies other than the safe-haven Japanese Yen last week as global stock markets fell apart and investors walked away from emerging market currencies in the their droves, and it has scope to continue outperforming in the short-term.

Europe’s single currency saw its biggest gains over the Dollar last week since August 2019 when China sent its Yuan falling to a decade-low, prompting steep losses for other emerging market currencies in the process. This was as coronavirus crept its way further beyond the borders of China, pushing deeper into Italy and France while also making a first appearance in many other European Union countries, not to mention the U.S. and other parts of the world.

“It is more of a position wash out,” says Jordan Rochester, a strategist at Nomura, of price action in the EUR/USD rate. “Short-term squeezes in EUR higher are possible due to leveraged fund positions closing out of carry trades, but real money positions are still net long and any reduction could also provide a headwind for EUR once the dust settles.

Europe’s single currency benefits from the recent pandemonium because negative European Central Bank (ECB) interest rates have made the Euro a popular 'funding currency' that sees investors borrow and then sell it in order to 'fund' bets on higher-yielding assets further afield. 'Carry trades" can result in the Euro-to-Dollar rate falling as stocks, commodities and emerging market currencies rise, only for the tables to turn as the apple cart rolls over.

It’s not clear what the path ahead has in store for emerging markets but Rochester says “rebalancing flows” could upset stock markets and keep the Euro supported into month-end, although he’s a seller of the Euro and is looking for it to decline to between 1.06 and 1.07 over the coming months.

"The fear is that Covid-19 will hit Europe hard in 1H20 and that is why we view the current EUR/USD rally as short-term and corrective in nature,” says Chris Turner, head of FX strategy at ING. “The ECB will be in no mood to jump in with a pre-emptive rate cuts, but could be forced to act were equities to continue to fall hard. Here the market looks like it is pricing a 10bp ECB rate cut over coming months. It is still not clear the ECB would go with a rate cut – e.g. an increase in the tiering of deposits is another option – but we hear little from the ECB ahead of the 12 March meeting.”

Price action will doubtless be dominated by the coronavirus story but the Eurozone will also see its first estimates of retail sales and inflation, although it’s not clear what impact they’ll  have on exchange rates. 

Markets are looking for inflation to have held at 1.4% in February, with core inflation at 1.1% when the numbers are released at 10:00 Tuesday while consensus is for Eurozone retail sales to have risen 0.6% in January when the number is released at 10:00 Wednesday.

“The perceived likelihood of a #covid19recession in Italy and perhaps for the Euro area as a whole has surely been sky-rocketing over the past week. The Euro-area manufacturing sector has been weak for a long while, and limiting movement of goods and people can’t be anything but bad news...For countries such as Italy, the service sector will also be hit hard as tourism will be severely affected,” says Martin Enlund, chief FX strategist at Nordea Markets. “EUR/USD looks nicely and inversely correlated with the S&P500 future for now.”

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The Dollar: What to Watch

The Dollar was sold heavily at times last week amid multiple headwinds for the U.S. currency, which might prevail over smaller, riskier rivals like Pound Sterling in the week ahead but could remain on the back foot against safe-havens like the Swiss Franc and Japanese Yen. 

The U.S. is also contending with its own first signs of coronavirus ‘community outbreak’ as well as meltdown in stock markets, both of which have helped send investors stampeding into the bond market, driving sovereign yields down to new record lows while derivatives market traders are increasingly pricing-in three interest rate cuts from the Federal Reserve (Fed) in the months ahead. 

“The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. The Federal Reserve is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy,” says Federal Reserve Chairman Jerome Powell, in a late Friday statement.

Three Fed rate cuts would obliterate much of the Dollar’s yield advantage against some major rivals if not offset by countervailing rate cuts from elsewhere, while the entire time that equity benchmarks are marching toward the bear market territory denoted by a 20% loss, the greenback could continue to be bloodied by outflows against a range of currencies. And for the Dollar Index, these losses are being exacerbated by outperformance from the Euro. 

“After such a pronounced correction lower in equity markets, it is very unlikely that this bout of risk aversion will reverse quickly,” says Lee Hardman, a currency analyst at MUFG. “Long-held positions are therefore in our view under greater risk of liquidation. The return of capital will be more important than the return on capital and hence position liquidation could have much more to run. The euro could be the surprise beneficiary here. Substantial outflows included in the ‘other investment’ outflow in BoP data indicates large use of the euro as a funding currency. Expect JPY, CHF and EUR to continue to benefit in these financial market conditions."

Europe’s single currency saw its biggest gains over the Dollar last week since August 2019 when China sent its Yuan falling to a decade-low, prompting steep losses for other emerging market currencies in the process.

This was as investors sold out of riskier bets that had been funded by Euro denominated borrowings in less turbulent times.

The Euro is outperforming for now but some expect it will eventually come back down to earth because its economy will also be hit hard by the evolving not-pandemic, which has already had a significant impact in Italy. And if the Euro does reverse course and head lower at any point then its 57% weighting in the Dollar Index could turn the tide for the greenback, which is still likely to get the better of smaller rivals like Sterling and the commodity Dollars. 

“The more severe the rally in the pair becomes, the more we are convinced that it is detached from underlying fundamentals. But this also means that we are less inclined to want to fight it,” says Stephen Gallo, European head of FX strategy at BMO Capital Markets. 

In the meantime, Institute of Supply Management (ISM) PMI surveys of the manufacturing and services sectors are due for the month of February this week and so too is the latest non-farm payrolls report although both events could easily be drowned out by the evolution of the coronavirus headwind. 

Consensus is looking for remarkable stability in the PMI surveys that won’t be difficult to disappoint. Markets are looking for the U.S. economy to have created 185k new jobs in February and for the unemployment rate to have fallen back to its earlier 3.5% level, with average hourly wages seen growing at 0.3% on a month-on-month basis.

“The situation is increasingly developing into a massive demand-shock rather than a supply-shock, why havens could be bought still. We fear that the Chinese PMI is a hint of what could be coming up in US and European key figures in a month or two,” warns Martin Enlund, chief FX strategist at Nordea Markets.