Euro has been unable to gain traction against major G10 peers suggesting mounting downside risk. The rationale seems clear for bearish sentiment. Incoming economic data, led by weakness in Germany has been troubling. Brexit chaos has highlighted growing risk of populism while China failure to stabilized growth despite heavy policy actions indicates export markets are declining. As we have noted in our “2019 Perspective” the gap between EU and USA has become extreme. Whether it is equity valuations or PMIs, the US has outperformed the EU. The factors caused repricing Euro lower. Yet the winds of change are blowing created an opportunity to go long EURUSD.
After continued acceleration US growth appears to be decelerating which will tighten the growth gap. The political division and partial government shutdown is having a clear effect in eroding growth (estimated between 0.5 to 0.75% slowing in annual GDP). Should the effect of divided nation start to damage consumer confidence this will become a significant issue. Treasury yields meanwhile, have settled into a narrower trading range between 2.65% and 2.75% the fall in US yields aided undercut the USD. EU PMIs have bottomed indicated stabilization, helped by competitive EUR pricing, while EU is still enjoying strong labor market allowing for consumer spending insulating GDP. Fiscally the environment is starting to loosen with Germany’s CDU has indicated that tax cuts are coming on top for Frances reversal of tax hike (due to yellow jackets protests). On the monetary policy front while M. Draghi recent comments have been dovish we suggest he has been focused on the near term and mid-term the ECB is on track to hike interest rates in September. In the US, expectation for additional rate hikes are waning as Fed Evans stated that this would be a good point for the Fed to pause. Tightening of yield spread differentials would certainly help the Euro as European investors, overweighed US assets, repatriate capital.
Elsewhere, news that Germany and China signed agreements to reinforce synchronization in banking, finance and capital markets, and promised to broaden and liberalize economic relations. China’s weak outlook mean the news has a lower impact but remains significant to help Germany’s economic fatigue. Whenever, FX markets become to one side it time to review the rationale. At this point we suspect the negativity around the Euro is accurately priced in and a reverse of bears trend is likely as negatives fade.