The Euro "Primed" to Sell

Spot Euro Rates:

• Euro-to-Pound exchange rate: 1 EUR = 0.8872 GBP
• Euro-to-Dollar exchange rate: 1 EUR = 1.2334 USD

© thanasak, Adobe Stock

“To us, the EUR looks ripe for consolidation versus the USD and looks primed to sell off on the crosses for several reasons” - CIBC Capital Markets. 

The Euro is likely to trade with a downward bias against the Dollar and other currencies during coming days argue a number of foreign currency strategists we follow amidst signs of waning upward momentum and a litany of risks to sentiment.

First and foremost among those risks is the spectre of a possible trade war that has loomed large over European industry ever since President Donald Trump announced tariffs on the imports of aluminium and steel into the US, drawing threats of retaliation from the European Commission.

“While the introduction of tariffs has been messy and the threat of a trade war percolates, we think this puts surplus currencies in the crosshairs and in particular, the EUR,” says Mazen Issa, an FX strategist at TD Securities. “While the Trump administration has adopted a shoot-from-the-hip trade strategy, it has at least, provided a 15-day window for other countries to lobby a petition to be excluded from tariffs.”

European Commission threats of retaliation against the White House drew a stern response late last week when President Trump wrote on Twitter that any such response would merely beget more tariffs on other products.

The European Union, wonderful countries who treat the U.S. very badly on trade, are complaining about the tariffs on Steel & Aluminum. If they drop their horrific barriers & tariffs on U.S. products going in, we will likewise drop ours. Big Deficit. If not, we Tax Cars etc. FAIR!

— Donald J. Trump (@realDonaldTrump) 10 March 2018

“Until that comes to fruition however, we suspect that EURUSD and EUR/crosses will trade with a downward lean especially as we head into this week's ECB and It's Watchers Conference where we expect a confluence of ECB [governing council] members to reiterate some caution on policy,” Issa says, referring to the possibility that Europe may be able to dodge the new tariffs using the 15 day appeal window.

“We would look for EURUSD to respect the broad 1.2150/1.2550 range.”

The US president singled out Europe’s automotive sector as his next target on Twitter last week, which is notable because European carmakers have significant operations in North America. However, while the US is their largest market outside of the old continent, it is unclear how tariffs would impact European auto manufacturers.

After all, Europe’s car firms have spent billions developing manufacturing plants in Mexico during recent years and, given the ongoing renegotiation of the North American Free Trade Agreement, Mexico has been exempted from the new tariffs unveiled so far.

Secretary of Commerce Wilbur Ross will be speaking with representatives of the European Union about eliminating the large Tariffs and Barriers they use against the U.S.A. Not fair to our farmers and manufacturers.

— Donald J. Trump (@realDonaldTrump) 12 March 2018

“To us, the EUR looks ripe for consolidation versus the USD and looks primed to sell off on the crosses for several reasons,” says Bipan Rai, a macro strategist at CIBC Capital Markets. “On the technical side, the EUR is vulnerable given how much it has benefitted from being the darling of the FX market since the French election last April.”

The Euro has risen by more than 16% against the US Dollar over the last 12 months, gaining an average of 3.7% per quarter for the four quarters to Monday 12, March. Rai flags that the last time a developed market currency enjoyed these kinds of gains was back during the financial crisis, when the Euro rose sharply against the Dollar during four quarters to March 2008.

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

“Outside of the crisis, we’d have to go back to 2003-2004. This type of long-term price action is atypical and if you’re playing the percentages, it makes sense to start thinking about taking some long EUR/USD risk off. Also, consider the post-ECB press conference last Thursday. Two things stuck out to us about Draghi when he spoke,” Rai notes.

Rai and the CIBC team flag the emphasis placed by European Central Bank chief Mario Draghi on how the Euro’s strength is becoming a risk to the bank’s attainment of its inflation target during last Thursday’s policy event as grounds for caution on the Euro. In addition, Draghi’s repeated emphasis that it will be some time before it fully normalises monetary policy also caught their attention.

“Taken together, it’s clear that the Bank is becoming more hawkish on currency gains. Further ECB guidance will be driven by the announcement of the QE end date and the reference to rates being low ‘well past the horizon of net asset purchases’. There’s no reason to change any of that for now and therefore all the more reason for EUR/USD to consolidate, and even trade defensively,” Rai concludes.

The ECB had been buying €60 billion or more of government and corporate bonds each month ever since the beginning of 2015 as part of a process known as quantitative easing, until it halved its purchases back in January.

Markets are now waiting for it to shutter the bond buying program completely, which would enable both European bond yields and the Euro to rise, although this isn’t expected to happen until at least September 2018.

Quantitative easing is designed to lift inflation by spurring economic activity, enabling the central bank to meet its obligation to ensure inflation remains close to, but below, the 2% target. It does this by forcing down bond yields, which is thought to reduce the cost of borrowing for companies and consumers in the real economy.

“The recent rally in the EUR has taken place on substantively lesser volume, while conversely the Dollar’s fallen on lesser volume. That was itself enough to get us bearish but add to that the confusion stemming from the Italian election and add further just the “talk” of tighter monetary policies but not real action of doing so in Europe...and we have both a fundamental and technical case to sell the EUR,” says Dennis Gartman, publisher of The Gartman Letter.

“We sold two units of the EUR upon receipt of this commentary at or near to 1.2390, looking for the EUR to make its way back toward 1.12-1.13. We’ll not want to see the EUR trade upward through 1.2535 on a closing basis here in North America.”

The Euro-to-Dollar rate was quoted 0.13% higher at 1.2319 during noon trading in London Monday.

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