The Eurozone Gross Domestic Product Figures that came out this morning confirmed what we already knew; things in the Eurozone may not be as bad as they may have seemed.
The main story of this week, however, is not the improvement of Eurozone growth prospects, but the fact that the euro remains as steady as a rock amid the bashing waves of rising US-China trade tensions.
The recent response by the single currency is the complete opposite to that seen last year in April and May when a surge in global trade uncertainty had the euro quickly sink below the $1.20 level.
It’s now different for the euro, which suggests the currency may be close to a bottom on EURUSD.
There are several reasons for the euro’s resilience to the current bout of trade tensions. When tensions rose in 2018, EURUSD was trading at a higher base – for a short period even around the $1.25 level – allowing plenty of room for depreciation.
2018’s flare-up in US-China trade relations coincided with the Eurozone’s economic transition from a period of booming growth at the end-of-2017 to moderate expansion in mid-2018. This then led to a dovish shift in European Central Bank policies, which would have brought the euro down on its own, regardless of any global trade concerns.
This time around, the market’s expectations of Eurozone growth sit at rock bottom, allowing plenty of room for positive surprises – which have been seen in Q1s data so far.
Additionally, the bar is set high for another dovish surprise from the ECB, with the reigniting of QE seemingly off the table for now.
Furthermore, the euro has found a layer of support from the unwinding of carry trades into the EM space. The sell-off of riskier currencies at the beginning of the week helped support the euro as many investors bought back into the original funding currency.
Taken together, this suggests that the euro may continue to prove resilient to taking another substantial leg lower.
Even with substantial support, significant downside risks remain. The support of unwinding carry trades, which has recently masked further euro weakness as tensions ramped up, could begin to fade.
The likelihood of this occurring increases should heightened tensions persist. Additionally, the US could begin to redirect the attention of its trade crusade towards the EU and automobile parts.
Even though we believe the announcement of tariffs towards the EU is unlikely this week, given that attention in Washington remains fixated on Beijing, the risk of tariffs on $53 billion EU exports will likely continue to linger over the euro in the near-term.
Taken together, the $1.10 level proves pivotal for the single currency should further downside risks materialise; either by trade tensions taking another leg higher or proving more permanent than current market pricing suggests.