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Should US Fiscal Tensions Ease, Euro Will Ultimately Gain

Should US Fiscal Tensions Ease, Euro Will Ultimately Gain

Christopher Vecchio, CFA, Senior Strategist
Should_US_Fiscal_Tensions_Ease_Euro_Will_Ultimately_Gain_body_Picture_1.png, Should US Fiscal Tensions Ease, Euro Will Ultimately Gain

Fundamental Forecast for Euro: Neutral

  • Euro hits highest level since February against US Dollar.
  • ECB shows hand – it’s decidedly “neutral.”
  • No LTRO unless crisis conditions reemerge.

The Euro finished the week relatively unchanged across the board, though it continued its climb against the US Dollar, finishing the week up by +0.27% after hitting $1.3646, its highest level since early-February. The Euro was mostly unchanged for the first several days of the week but was uplifted by a decidedly “neutral” European Central Bank, one that remains ready to act but not in a hurry to administer additional stimulus.

The shift in ECB signaling – from that previously of suggesting a third LTRO could be around the corner, given the region’s struggles with weak inflation, poor credit creation, and overall low growth – indicates that a more distant approach will be taken with monetary policy in the near-term. Essentially, ECB President Mario Draghi said that another LTRO would only come about if crisis conditions were to re-arise – and there would be no question that “all instruments” would be used.

This alteration in stance is similar to what the Bank of England has done under Governor Mark Carney: against broader perception that additional easing would be implemented, the BoE decided to stay on the sidelines and let its current policies cycle through. And, after a year of the Funding for Lending scheme active – viewed as essential for helping small- and medium-sized enterprises receive credit – the UK economy is showing signs of exceptional resilience. In fact, the UK services sector just had its strongest quarter in 16 years in the 3Q’13.

The Euro, then, finds itself in a rare situation, at least relative to the past few years: its central bank is refraining from stimulus as the region’s economic recovery is sufficient enough to allow organic growth to attempt to find footing. This also means that economic data will play more of a role – if data continues to stumble, then the ECB could explore options that would be similar to the BoE’s Funding for Lending scheme; that would help resolve the region’s weak credit growth and inflation issues. Another massive liquidity injection like another LTRO is therefore unlikely.

Absent a crisis, ECB easing may have reached its apex and only the premise of forward guidance will change going forward. Italy’s political crisis was anything but one after the Centre-Right party broke rank from former Prime Minister Silvio Berlusconi and reaffirmed the Centre-Left’s leader Enrico Letta as the Italian premier. With the German elections out of the way and Chancellor Angela Merkel receiving sweeping support, the region looks free of any major political issues unless Greece becomes an issue again.

While the Euro slid to end the week, it is likely that dips are treated with buying interest overall, though it may be necessary to see a shakeout period: the Commodity Futures Trading Commission’s Commitment of Trader’s report shows that non-commercials/speculators are the most bullish the Euro since the May 2011 top – when the EURUSD traded above $1.5000.

To this end, a resolution of US fiscal issues will ultimately clear the way for the Euro to proceed on its more natural upward progression rather than one dictated by speculation over whether or not the US political circus will continue. In July 2011, even on the cusp of the Euro-Zone crisis swelling, the EURUSD only declined by 500-pips over the course of three tense weeks as US policymakers feuded; we suspect that a similar rush to safety would occur should the October 17 debt ceiling be approached. As long as the line of lunacy isn’t crossed in the US, any near-term dips in the EURUSD may be viewed as buying opportunities for strength throughout the 4Q’13. –CV

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.