EUR/USD is "Good Value" at 1.17 says CIBC but Others Eye Italy and Risk of Further Losses

-EUR "good value" around 1.17 says CIBC Capital Markets.

-EUR should see solid support at 1.17 says TD Securities.

-Avoid EUR/USD and short EUR/CHF says Credit Suisse.

© Lisa L, Adobe Stock

The Euro likely bottomed out at a six-month low this week, according to strategists at CIBC Capital Markets, who argue the exchange rate now offers "good value" to speculators brave enough to bet on a recovery.

This call comes as the Euro-to-Dollar rate continues to rebound away from the 1.17 handle, a key area of technical support that corresponds with the 32.8% retracement of the trend spanning the January 2017 low to the February 2018 high, and after a torrid month for the currency pair. 

Europe's single currency has fallen from Grace in spectacular fashion since late April as a softening of economic growth at the start of the year culminated at the end of April with a surprise fall in Eurozone inflation, which conspired with a resurgent US Dollar to drive the Euro from a near 3% gain for the 2018 year-to-date to a 1.7% loss. 

Risks to the outlook for the currency have mounted further in May as Italy's two largest political parties, the anti-establishment M5S and League, edged closer to forming a coalition government that threatens to put Eurozone breakup risk back on the agenda for markets. 

Fears are that with growth softening and inflation having disappointed the market for the third time this year, the European Central Bank (ECB) will delay the winding down of its quantitative easing (QE) programme, leaving the Euro vulnerable to a US Dollar that is now succesfully exploiting the widening gulf between interest rates in the US and those in the old continent.

"Slowing economic momentum in the Eurozone and Japan begat shifting sentiment on both central banks and the rise of inflation premiums globally. That has led to squaring of excessive USD shorts – a process that continues now with spot EUR/USD providing the clearest barometer of market positioning," says Bipan Rai, an FX strategist at CIBC Capital Markets. "EUR/USD at 1.1700 offers decent value for longs, but that’s contingent on a bounce back in data."

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

Rai is not alone in eyeing the 1.17 level as a source of likely support and a potential entry point for speculative trades as strategists at TD Securities also flagged it, in a note, as an area worth keeping an eye on this Tuesday.

"We think that EUR may be close to finding a base; on the charts, we think 1.17 will grow in significance to offer EURUSD support. We are also cognizant that we may be in the early days of a bullish divergence with the daily RSI deeply and persistently in oversold territory but EURUSD potentially in the process of carving out a trough," writes Mazen Issa, an FX strategist at TD Securities.

Rai and the CIBC FX team note the Eurozone economic surprise index fell sharply from previously high levels at the end of the fourth-quarter but that it still remains above its long term average and purchasing managers' indices are also still consistent with above trend levels of growth.

They argue this should mean the ECB is not discouraged from shuttering its QE programme later this year, which is essential to the narrative around the single currency because an end to the central bank's intervention in Europe's bond market is a prerequisite for any eventual interest rate rise. A complete end to the QE programme could be announced in either late June or late July, according to CIBC. 

"While the majority of ECB members will want to see some momentum in core inflation as well as evidence that the Q1 slowdown in growth was transitory before saying much, look for further signals of stimulus withdrawal to come at the June 19-20th symposium or July 26th meeting," says Mario Robles, a CIBC colleague of Rai's. "At that time, we should see the euro making gains against the US$, with EURUSD reaching 1.25 by the end of the year and 1.32 by December 2019."

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

Rai, Robles and the CIBC team, like many others, still hold a bullish view of the Euro. They do not raise Italian politics as a potential hurdle to a recovery in the Euro-to-Dollar rate and are instead focused on the continental growth and monetary policy story. This may yet prove to have been the right call, although others are taking a more cautious approach to Italy and the single currency as a whole. 

"The risk of a populist Italian government actively looking for confrontation with Eurozone rules and institutions requires a political risk premium for the EUR, much like was seen in the period before the 2017 French presidential election. But it's also possible that the risk of Italian stresses hurts business sentiment across the euro area in coming months," writes Shahab Jalinoos, an FX strategist at Credit Suisse, in a note last week. 

Jalinoos and the Credit Suisse team have advocated that clients of the bank avoid trading the Euro-to-Dollar rate and instead focus their resources on betting the Euro falls in value relative to the safe-haven Swiss Franc. They argue the market is yet to fully price the risks emanating from Italy into Euro exchange rates. 

"In the light of the long (and at the time perplexing!) lack of market reaction to the steady stream of poor news emerging from Italian politics, we see the balance of risks as asymmetrically more likely to generate a large EUR-negative reaction in the event of an announcement of a 5MS/NL government, rather than in a more benign scenario," Jalinoos warned.

Documents leaked to Huffington Post Italy last week showed both League and Five Star Movement parties plan to ask the European Central Bank to forgive €250 billion of Italian debt acquired through its quantitative easing programme. They also revealed discussions have taken place about a possible push to reopen the European Union Treaties and insert a Euro exit clause, much like the Article 50 clause in the Lisbon Treaty that enables a country to exit the EU.

This would be an incendiary government agenda for markets that places a question mark over everything from the new government's commitment to honouring its debts, to the very survival of the Euro as a currency. In fact, fears over exactly this kind of agenda were what made Italy's March election and subsequent negotiations over forming a government such a big event for markets in the first place.

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