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EUR/USD Still in Demand Despite Political and Economic Headwinds

EUR/USD Still in Demand Despite Political and Economic Headwinds

Martin Essex, MSTA, Analyst

Talking Points:

- Euro-Zone GDP growth is confirmed at 0.3% in Q3 but could slow in 2017

- Italy’s political turmoil is still a concern, as are the problems at Banca MPS

- Yet EUR/USD is shrugging off the Euro-Zone’s problems

Once more, the FX market has shrugged off bad news. This week, it was the ‘no’ vote in Italy’s constitutional referendum. Previously, it was the UK’s Brexit vote to leave the EU and the election of Donald Trump as the next US President.

In the Euro-Zone at least, the argument appears to be that bad news is good news because the more the political backdrop deteriorates and the more the economy struggles, the more likely the European Central Bank is to keep the region’s monetary policy loose. While that might be expected to weaken the Euro, it is good for Italian businesses and banks, and doesn’t change the outlook for an eventual “tapering” of the ECB’s support next year.

Euro-Zone GDP growth was confirmed at 0.3% quarter-on-quarter in the third quarter of 2016 on Tuesday, unchanged from the previous three months. The breakdown of the figures continues to suggest that growth will slow in 2017 from around 1.6% this year but that doesn’t alter the prospect of the ECB tightening monetary policy at some stage in future.

As for the Italian political situation, the ‘no’ vote in Italy was no surprise and doesn’t change the likelihood that the ECB will announce a six-month extension of its asset-purchase program from March to September 2017 when it meets on Thursday, or that it will eventually change course.

Still, with US interest rates set to rise and Euro-Zone monetary policy likely to remain accommodative, the strength of the Euro since the Italian referendum seems to turn conventional wisdom on its head, unless the latest move simply represents short-covering by traders expecting the euro to fall. The last Commitments of Traders report from the US Commodity Futures Trading Commission showed Euro shorts continuing to consolidate at levels just below their recent highs.

The problems of Banca Monte dei Paschi di Siena might also be expected to heighten market jitters yet the spread, or difference in yield, between 10-year Italian government bonds and their German equivalents – a measure of the perceived extra risk in buying Italian bonds rather than German – has actually fallen to 1.6 percentage points from 1.7 just ahead of the referendum.

Moreover, Italy, despite being the Euro-Zone’s third largest economy, isn’t the Euro-Zone, and Banca MPS isn’t a typical European bank – or even a typical Italian bank – and would likely be rescued by the Italian state if that proves necessary. The FTSE Italia banks index was up 2.5% by lunchtime in Europe Tuesday, compared with a 4.5% fall for Banca MPS. The five-year Italy credit default swap – a measure of risk – was at 1.74 percentage points, down from 1.75 a week earlier.

For now, the markets are giving the Euro, despite the problems for the domestic Italian economy, the benefit of the doubt.

Read more: Italian Ref is Bad for Italy, Maybe Good for EUR; Brexit Looks Soft

--- Written by Martin Essex, Analyst and Editor

To contact Martin, email him at martin.essex@ig.com

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

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