- EURUSD is the benchmark for which we measure the Euro's performance, but the pair's slide has deviated from the currency pace
- A Euro slide in earnest has started just over the past weeks amid recognition of unrealistic enthusiasm and new risks ahead
- Italian bonds and the FTSE MIB tumbled to start the week as the country's coalition government poses a threat to the Euro
Separating the Euro from EUR/USD
The Euro has found itself tipped into a painful retreat over the past five weeks - but really only against the US Dollar. The world's second most liquid currency has certainly lost ground against a number of its other major counterparts over the same period, but the progress has been mainly concentrated to pairs where the foil has leveraged a particularly intense rally of its own. When you extract the Euro's performance from a pair like EUR/USD, we find that currency has more or less spent the past six months carving out a broad range. This resilience and lingering strength defies more recent fundamental evaluation. Rate expectations, general returns and economic growth were all relative boons for the Euro-area economy through 2017, but those advantages have all faltered over time. And yet, the currency has held its bearing. What is interesting about the benchmark currency pair is that the Dollar's own strength is generally borrowed through a collective depreciation of counterparts. That plays an important role in the throttled pace for the pair and its individual components.
The Euro's Fundamental Environment Sows the Seeds of Doubt
While the Euro has offered a restrained performance of its own these past months, a bearish pressure has re-emerged recently. Beyond the currency's benchmark counterparts taking advantage of its drift, there is a growing recognition of its own fundamental troubles. The explicit effort by the European Central Bank (ECB) at its last meeting to steer speculation away from a hawkish forecast that had earned the Euro significant lift among its peers helped to highlight the exceptional premium the currency has traded at. The 1Q GDP readings, monthly PMIs and array of sentiment surveys all further served to set more realistic expectations for economic activity and the speculative draw it had provided. What has really brought the market's discerning eye back on the lofty exchange rate though has been the emergence of a theme that had been pushed to the backdrop over the past few years: political risk.
Re-igniting the Euro's Fire
Since the results of the Italian election on March 4th were tallied, the Eurozone's third largest economy has struggled with forming a workable coalition government. Over time, it has grown clear that two populist parties were looking to form a relationship of convenience and mutual distaste the European Union and the shared currency. Last week, a draft document of their general objectives and demand were leaked, and their intentions were as troubling for regional unity as the most dovish had feared. They were supposedly preparing to demand debt forgiveness from the ECB on approximately 250 billion euros in debt purchased during the QE and LSAP efforts, call for treaties rewriting and make it easier to exit the Union should it be put to a vote in the future. Over the weekend, a more official list has softened on more of the extreme measures, but a push to scrap the common budget objective was still putting Italy on a dysfunctional collision course with its collective counterpart.
What's at Stake and What's to Trade
For those that were not in the markets, up to date on international affairs or not European; we experienced a crisis of confidence in the Euro area not long ago. Back in 2009 and 2010, Greece had ignited a financial crisis for the shared currency when it was discovered that the country had far more debt than reported when it was accepted into the Union thanks to derivatives positions. The leverage it had carried triggered investor fear that rapidly spread through the region requiring bailouts for Greece, Portugal, Ireland, Spain and Cyprus. Bailouts and a massive infusion of stimulus by the ECB staved off full collapse, but the policy authority has been left spent and the markets remain wary. Moving forward, if fear further foments into another crisis, there is considerable premium still built into the Euro that can be unwound. The EUR/USD is well suited for such a development, but there the EUR/JPY and EUR/CHF are also adept for the risk aversion implications. There is also considerable technical appeal for pairs that actually provide yield but have been deprecated through speculative channels over time like EUR/AUD. We focus on the risk and potential behind the Euro by emergent risks in today's Quick Take Video.