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Let’s Try to Make Sense of the Euro

 
By Andrew C. Collins, Managing Partner |Bannockburn Global Forex, LLC
 
The Euro:
 
While most of us were grilling hot dogs and burgers or setting off fireworks or boating or sunning at the pool, global markets were open and active, and it was a pretty ugly (oxymoron intended) few days for the euro.  Political concerns in Italy (I’ll come back to this later) sent the euro sharply lower, extending and accelerating its recent losses.  EURUSD touched 1.1506 overnight, down from its Friday open at 1.1725; the battered single unit dead-cat bounced to almost 1.1600 but currently hovers at 1.1536.  More broadly, after topping out above 1.2550 back in February, the euro has plummeted nearly ten full cents against the dollar, or a 7.8% move in just over two months’ time.  Looking at the chart below, the euro has now shed all of its gains since October last year, and technicians are pointing to further losses. 
 
 
Looking back at why the euro rose at the tail end of last year and early this year, and how those trends are reversing/have reversed may help us determine how much further it has to go on the downside.
 
1.Unknown Fed trajectory – the market was grappling with how many rate hikes the Fed would enact this year – that trajectory is now on the hawkish side of center.
 
2.ECB scaling back of easing measures – the market was digesting the ECB’s declining asset purchases, and expectation that such purchases would end in September this year.  Now that expectation is reversing, and with Italy’s political situation in the crosshairs, the ECB may be forced to indeed extend those easing measures well beyond September or even year-end.
 
3.Equities/risk assets were in rally mode.  Now, investors are concerned with a variety of risk-off issues: Europe’s political landscape (Italy and Spain), widening sovereign yields, NoKo geopolitical tensions, and an ever-developing EM currency crisis, particularly in Turkey, Argentina, Venezuela, South Africa, and Brazil.
 
4.Italy – this is the wild card.  Trying to simplify things here (and it isn’t easy), Italian President Sergio Mattarella has asked former IMF official Carlo Cottarelli to form a coalition government, but he faces stiff opposition from the two populist parties in Italy who hold the most seats since March 4 elections – the anti-establishment 5Star Movement and the far-right League.  Those parties wanted Mattarella to tag 82-year old Paolo Savano, noted for his anti-euro sentiment, as economy minister, but Cottarelli did not oblige.  In retaliation, it is unlikely that Cottarelli will garner enough support, and a no-confidence scenario means elections would likely be held in September.  Stay tuned.
 
Another interesting consideration is Italian bond yields.  At the beginning of April, Italy’s 10-year yield was below 1.50%, and by the end of April was still steady at 1.53%.  Ahead of this past weekend, it stood at 2.20%, and now is a whopping 2.41%.  This feels a little (ok, a lot) like the Eurozone debt crisis in 2011-12 when sovereign yields widened significantly and threw Europe into full-on crisis mode; the EUR plummeted from 1.50 to 1.04 over the next four years.  Hmmmm…
 
 
My view on the EUR from here – there is a LOT of uncertainty in Italy, and September elections – assuming that’s when they are – feel like a very long way away.  Even if we get a positive outcome on the on again-off again NoKo/US summit, there seem to be more negative EUR issues out there than positive ones. Looking at the chart above, the euro move lower looks incomplete.  Risk assets overall feel heavy, and there seems to be more downside risk than up from current levels.  My medium-term target for the euro – 1.1000.
 
Other currency pairs of note:
USDJPY: Risk-off sentiment always benefits the yen – this time is no different.  After peaking at 111.40 on May 21, this pair now sits at 108.61.  Next support is in the 108.20-25 area, which represents both the 50 and 100-day moving averages. 
AUDUSD: The Aussie has fared better than most currencies.  It and the kiwi are the best performing G10 currencies against the dollar outside of the safe-haven JPY and CHF, likely the result of calming trade tensions with China. 
GBPUSD: Brexit is never far from the minds of traders, but mainland Europe issues are currently far more topical and impactful.  Keep in mind that EURGBP was around 0.7600 pre-Brexit and is now .8715.  This pair topped out near .9300 in August last year.  In other words, GBP has recovered against the EUR, but not significantly.  One would think that given Europe’s issues, this would be the time for the GBP to make hay.  Instead, GBPUSD is being sucked down in the EUR downdraft.  GBPUSD now trades at 1.3250, with the next BOE meeting scheduled for June 21, at which no change in rates (0.50%) is expected.
USDCAD: The loonie has popped through 1.30 again on the back of lower oil.  Last week’s report that Russia and Saudi Arabia agreed in principle to boost oil output is one factor pushing oil lower and the CAD with it.  2018’s high water mark of 1.3125 is the next target.
 
 
Emerging Markets:
 
USDTRY: Inflation risks in Turkey have sent the TRY plummeting.  The Lira is the second-worst performing currency on the planet this year (with a nod to the Argentinian Peso); USDTRY is now trading at 4.5450.  That said, yesterday offered a reprieve for the beleaguered currency, as the government gave the central bank a bit of latitude, which resulted in a one-week repo rate being re-established as a key policy tool; the rate was set at 16.5%.  We’ll see if this stop-gap has any staying power – my sense is probably not.
USDBRL: Brazil’s Real is just behind the TRY on the aforementioned, worst performing list; it is 12.8% weaker against the dollar this year and sits at 3.7395.  Truckers protesting high diesel prices and an ongoing government scandal are adding to BRL’s woes, already damaged by the general EM slide.  BRL’s all-time weak level of 4.24 in 2015 feels safe from being breached…for now.
USDMXN: the MXN is not immune from the EM sell-off, currently at 19.8220.  Keep in mind that post-Trump election, USDMXN traded above 22.00.  We’re still over 10% away from those levels, but NAFTA negotiations add an element of concern specific to the peso versus the EM space in general.  20+ seems like a foregone conclusion, and the next significant level of resistance from there is not until 20.8400.
 
Indications:
EUR:      1.1542
GBP:      1.3242
JPY:       108.66
CHF:      0.9920
CAD:      1.3023
AUD:     0.7508
NZD:      0.6898
SEK:       8.9560
DKK:      6.4474
NOK:     8.2874
RUB:      62.8185
CNY:      6.4176
INR:       67.8725
SGD:      1.3476
PHP:      52.687
HKD:      7.8455
BRL:       3.7344
COP:      2907.52
MXN:    19.8120
 
With volatility picking up, please contact your Bannockburn Global Forex (www.bannockburnglobal.com) specialist if you have FX market questions, concerns, etc.
 
Compliments of Bannockburn Global Forex, LLC, a member of the EACCNY