Key Takeaways

  • Pulled higher by a broadly weakening dollar, the euro gained nearly 12% through the summer months.
  • Surging coronavirus infection cases across Europe, returning Brexit stress and rising US “election risks” are pushing nervous investors to the safety of the dollar, which may continue into the year-end.
  • A growing number of analysts expect Europe to enjoy an earlier Covid-19 recovery than the US, leading to a quicker economic upturn. If this scenario plays out, European assets and the euro will be increasingly attractive to global investors.

Spot (mid-market) rate = $1.1647/ USD (11:20am, September 24, 2020)

Latest uptrend in the euro on hold. Pulled higher by a broadly weakening dollar, the euro gained nearly 12% through the summer months. On September 1, the EUR/USD reached $1.20,1 a key objective for many currency speculators, prompting profit-taking and turning the euro lower. This week, the euro has fallen further. Surging coronavirus infection cases across Europe, returning Brexit stress and rising US “election risks” are pushing nervous investors to the safety of the dollar, which may continue into the year-end.

Mounting expectations for Europe to outperform the US. A growing number of analysts expect Europe to enjoy an earlier Covid-19 recovery than the US, leading to a quicker economic upturn, and eventually, a tapering of monetary stimulus by the ECB before the Fed. If this scenario plays out, European assets and the euro will be increasingly attractive to global investors.

G-10 Currencies Spot Returns (%) vs USD since September 1st, 2020

Europe suffering from a Covid-19 second wave.

  • Countries across Europe are seeing a resurgence in coronavirus cases after successfully slowing outbreaks during the summer months.

  • The World Health Organization (WHO) has warned Europe to prepare for an increase in deaths in October and November, prompting many countries to toughen up measures to control the spread.2

  • Since August, Spain and France took the lead in infections across Europe. Along with Italy and Germany, these are the most infected countries in Europe. Nevertheless, together, they equal less than 20% of US cases.3

European Central Bank ever more dovish, and unhappy with the strong euro.

  • Structural forces have kept eurozone inflation lower than in the US. At the recent ECB meeting, Executive Board Member Fabio Panetta said the central bank should err on the side of doing more to lift inflation and keep the economic rebound on track.

  • Concerned with the strong euro, Panetta said, “The sustained appreciation in the external value of the euro has brought about an undesirable tightening of financial conditions and has offset some of the monetary accommodation provided by our measures.” 4

  • The ECB next meets on October 29, and most analysts predict its benchmark rate (currently at -0.50%) will be left unchanged. However, at its December 10 meeting some analysts predict that its €1.35 trillion PEPP (pandemic emergency purchase program) will be expanded.

Two-speed economic recovery in Europe.

  • Germany is rebounding from the pandemic more strongly than its southern neighbors, including Spain, Italy and Greece.

  • Pre-pandemic, Spain grew faster than the eurozone average, while Germany approached a recession, its auto sector struggling with the switch to electric vehicles. Roles reversed as the pandemic spread across Europe, with Spain’s tourist-reliant economy contracting by 22% -- almost double Germany’s fall of 12%.5

EU recovery fund is a symbolic game changer for Europe and the euro.

  • The EU’s €750 billion recovery fund reflects European unity, and nearly eliminates existential risk for the euro. Together with a generous seven-year budget, this financing from joint EU members unlocks a €1.8 trillion spending boost.6

  • The EU will soon become one of the world’s biggest supranational bond issuers, providing central bank reserve managers around the world with another pool of “safe” assets: euro-denominated EU sovereign bonds (comparable to AAA-rated US Treasury bonds).

Technicals:

The euro’s turnaround rally since March effectively reversed a multi-year downtrend versus the dollar. We expect that this signals the beginning of a medium-term (or longer) uptrend in the EUR/USD. It will not, however, be without the occasional set-back. This month’s selling of the euro represents a corrective move lower caused by: 1) an overbought condition in the euro (see RSI in bottom window); and 2) overcrowded “long” positions in the euro by large currency speculators. Our target for a correction is the retracement “box” of the entire up-move from $1.0636 to $1.2011— the $1.13-1.15 range – which will likely be reached before year-end, when we expect the euro to resume its uptrend.

Medium-term EURUSD uptrend intact, but overnight, so may correct lower

Final comments:

Europe and the euro are relatively well-positioned for success. Despite a recent uptick in coronavirus cases and a sell-off in the euro, an increasing number of analysts expect eventual improvement and even outperformance. Meanwhile, investors face multiple risks over the remainder of the year -- US elections, a new fiscal stimulus package, US-China-Taiwan tensions, stalled EU-UK Brexit negotiations, an overvalued equity market, and, of course, Covid-19. Demand for the dollar as a safe haven has been the end result. Next year the markets may tell a different story.

Please feel free to reach out to your SVB Currency Advisor for a deeper discussion about FX, what impact it may have on your firm, and ways to mitigate risk.

1 Bloomberg

2 “Coronavirus: Europe must prepare for rise in Covid-19 deaths in October and November, warns WHO. Euronews with AFP. September 15, 2020.

3 Marc Santora. “With Coronavirus Cases Surging, Europe Braces for New Phase in Pandemic.” The New York Times. August 21, 2020.

4 Reuters Staff. “ECB should err in doing to much rather than too little: Panetta. Reuters. September 22, 2020.

5 Daniel Dombey. “Diverging fortunes for Europe’s two-speed economy.” Financial Times. September 17, 2020.

6 Laurence Norman. “European Union Leaders Agree on Spending Plan for Recovery.” The Wall Street Journal. July 21, 2020.

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Scott Petruska, CFA
Written by
Scott Petruska, CFA
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