Euro-to-Dollar Rate a “Buy on Dips” as Strong Growth Matters More than the ECB says Deutsche Bank

“An analysis of the flows driving the euro higher last year points to these being largely beyond the ECB’s control. First, there is Foreign Direct Investment (FDI) flows...Then we have equity flows.” 

The Euro-to-Dollar rate will rise steadily over time as economic growth picks back up and foreign investors return to the continent, according to strategists at Deutsche Bank, who say speculators should buy the single currency amid bouts of weakness in order to exploit this uptrend.

Friday’s EUR/USD exchange rate could be viewed as offering one such opportunity as markets have seen the pair offered lower and lower throughout the morning.

Price action comes as traders look past a market-neutral ECB monetary policy statement to focus instead on risks around a White House decision to impose tariffs on American imports of aluminium and steel.

The Euro was quoted 0.04% lower at 1.2301 against the Dollar after having fallen steeply overnight, leaving back at Monday’s starting level and the second worst performer against the greenback in the G10 basket Friday.

“The most important signal we will be watching is that the overall path towards policy normalization remain intact. So long as this is the case, we would remain buyers of EUR/USD on dips. The flow “normalization” story has more to run,” says George Saravelos, an FX strategist at Deutsche Bank.

Above: EUR/USD rate shown at hourly intervals.

The European Central Bank drew curious glances when it tweaked some key language inside Thursday’s statement, giving markets the impression the bank not countenance an about turn on its commitment to winding down the quantitative easing program that has seen it hoovering up €60 billion or more of European bonds each month since early 2015.

However, simultaneously, the ECB downgraded its projection for inflation in 2019, which took some excitement out of the market. 2019 consumer price inflation is now expected to be 1.4%, down from 1.5%, which is unwelcome news for the Euro because it is is inflation that the ECB has been trying to coax through its bond buying and low interest rate policies.

“An analysis of the flows driving the euro higher last year points to these being largely beyond the ECB’s control. First, there is Foreign Direct Investment (FDI) flows,” says Saravelos. “Then we have equity flows.”

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Monetary Policy a Lesser Factor Now

Turns out ECB monetary policy has only had a small direct effect on the EUR/USD exchange rate, which has risen 17% in the last year, with real money flows into continental real asset and stock markets mattering more for the single currency.

“From more than 200bn EUR of outflows in 2016, net FDI turned neutral over 2017. As confidence in the European recovery has grown, companies have become more focused on domestic acquisitions, pushing Europe's basic balance materially higher last year,” Saravelos writes, in a recent note.

It was an exodus of these kinds of investor that drove the Euro down toward parity with the Dollar during and after the crisis years, according to Saravelos. They are now in the process of returning to the continent, which is supporting and helping to propel the meteoric rise of the common currency.

“Our high-frequency ETF data shows that despite the recent sell-off American holdings of European stocks remain remarkably sticky. In fact, foreigners are rotating their holdings from hedged to unhedged exposure to take advantage of a rising euro,” Saravelos adds.

All of these money flows into Europe will be much more sensitive to changes in Eurozone economic growth than they will to tweaks in language within the European Central Bank’s regular monetary policy statements. And Eurozone growth is on the up.

Eurozone GDP growth was 0.6% in the fourth quarter of 2017, which makes for annual economic growth of 2.3% and the currency bloc’s best year since 2011.

“The conclusion cannot of course be that the ECB is not relevant. The “elephant” in the room remains European fixed income outflows which at -400bn EUR just about offset Europe's current account surplus. The sensitivity of these flows to rising European rates should naturally be higher,” says Saravelos.

“From a bullish EUR/USD perspective all that is needed is an easing in the pace of outflows to generate further improvements in the basic balance.”

Above: EUR/USD rate shown at weekly intervals.

EUR/USD Drops as Trade Threat Ramps Up

President Donald Trump announced late Thursday that America will levy tariffs of 10% and 25% respectively on all imports of aluminium and steel into the states, with the exception of those that come from Canada and Mexico, under section 232 of the Trade Expansion Act of 1962.

Countries will have the opportunity to apply for exemption and so too will American users of steel and aluminium products in the states, where they are unable to find a suitable alternative product that is made in America. The tariffs go into effect in 15 days time.

Tariffs come at the tailend of a week long period where Washington’s rhetoric on international trade has hardened, particularly around metals and the North American Free Trade Agreement.

Bodies such as the European Union, as well as some countries, have threatened retaliatory measures if they are targeted, prompting concerns over a possible trade war.

The European automotive sector will be among the first victims of the White House tariffs, which are to be applied across the board to all countries, raising the spectre of a retaliation.

This may explain why the EUR/USD rate fell steeply during late noon trading Thursday and overnight into Friday, dropping from 1.2420 Thursday afternoon to around 1.2300 by noon.

European carmakers have spent billions of Dollars building supply chains in Mexico to support sales into the United States during recent years. America’s tariff rate on European car imports is just 2.5% where the European Union external tariff is 10%.

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