- Our bearish EUR rationale
- What risks and triggers would make us change our view?
- Developing tech set-ups
EUR shorts vs USD and GBP: Our bearish EUR rationale is being driven by 3 factors 1) Diverging economic backdrop, 2) ECB stance and 3) Political uncertainty. EUR remains under selling pressure with EURGBP breaking the 200d MA.
- Diverging economic backdrop
Peripheral EU countries face strong headwinds with local funding costs rising sharply resulting in growth and inflation differentials diverging. While EMU core countries are experiencing a reflationary boom the peripheral countries deal with disinflationary pressures which are having detrimental effects on their financial and economic stability. The EUR outlook depends heavily on the performance of the Italian economy. For Italy to improve we need to see easy financial conditions however BTP spreads continue to widen. The correlation of the EURUSD and BTP spreads has been high during times of Eurozone crisis and we are starting to see a pick up in the correlation.
- ECB stance
The ECB current monetary policy has to cater for its weakest link. While 2yr German Government bond yields are at an all-time low of -0.906% generating losses for core EMU central banks this should not pressure the ECB to shift from its easing stance. If the ECB did taper QE further the costs to the periphery countries would be detrimental resulting in further widening of spreads. For ECB to have the highest probability of economic and financial stability they will need to implement policy that will weaken the EUR which should ease the pressure on peripheral economies.
Figure 1 German government bond 2yr yield
- Political uncertainty
Leading into the European election cycle we see pressure mounting on Eurozone stability as the threat of a populist movement gains momentum. French polls have enhanced market uncertainty as there seems to be a wide range of outcomes that could unfold. Populist candidate Le-Pen is gaining momentum and her election could fuel a potential Eurozone break-up theme.
Risks to our view causing the EUR to strengthen
- ECB indicating they could taper this year. This outcome seems improbable to us as ECB policy needs to be tailored to support the weakest economies to promote stability.
- Eurozone break-up worries diminish. Given the long list of political risk events throughout 2017 this risk seems unlikely to materialise.
Developing tech set-ups
Figure 2AUD futures failed to break higher while 13d Net Volume EMA shows divergence