Morning Commentary: Warning Shots

Foreign Exchange - Morning Commentary
Warning Shots
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Yesterday, the European Commission (EC) issued a warning on the risks to the European economy if COVID-19 risks are not properly handled.  To me, the EC’s admission that the European Project could be at risk represents a major pivot from past episodes of stress where senior European leaders steadfastly maintained belief in the European Union.  

To be clear, the EC’s warning is more of a call to action for Euro leaders than an indication that a breakup is near, but it does support our view for a weaker euro.  
According to many estimates, EURUSD is undervalued.  Moreover, the recent rally in risk assets, due to stimulus and declining infections rates, has helped support the euro.  However, many headwinds remain as follows.

Weak global outlook 

The global outlook remains negative as GDP and PMI data series show, but within this broad based negativity is the Eurozone recession that should be deeper than the US recession. 

Eurozone policy support has been weaker

On average, fiscal stimulus in the Eurozone has been about 2% of GDP, which places the EZ near the bottom of G10 countries.  By comparison, fiscal stimulus in the US is around 9% of GDP.

Monetary policy constraints

Most G10 central banks have convinced the markets that their unconventional policies are open-ended.  Case in point, the Fed is running a program that the markets call “QE infinity.”  Conversely, the ECB remains constrained as this week’s German Constitutional Court decision highlighted.  Notably, the PEPP, which is exempt from the German court’s ruling, is only temporary.   

The market remains long euros

Market data shows that the market is long euros with euro positioning one of the longest positions in the G10.  Being long could accelerate euro weakness should market participants rush to reposition their holdings. 

The key risks for a strong euro include the near term development of a vaccine or treatment that would improve the global outlook and a breakthrough to mutualize debt.  Unfortunately, both of these factors appear unlikely.  
  • Initial jobless claims came in at 3.17 million, which was worse than market consensus but better than last week.  Markets have more or less shrugged off the number as focus remains on reopening the economy.  As of this writing, the NASDAQ has turned positive for the year.  
  • The government’s jobs report will be released tomorrow.  Market consensus is for a loss of 21.3 million jobs and an unemployment rate of 16.0%.  However, it should be noted that many of the jobs lost (jobless claims) are self-employed and will not be included in payroll employment reports.  This means that tomorrow’s payroll report likely underreports the change in employment and the unemployment rate.         
  • US-China trade moves back to center stage with a phone call between the two countries scheduled for as soon as next week.  The sudden halt in economic activity means that Chinese purchases of US goods are behind the pace set in the Phase 1 agreement.  Overnight data showed a surprise jump in Chinese exports but a sharper-than-expected drop in imports.  
  • News headlines suggest that the House of Representatives could vote as soon as next week on another relief package.  
  • BoE held rates unchanged but signaled that it could expand stimulus as soon as next month.  
  • Norway’s central bank cut rates to 0% in a surprise move as the country is being hit by both shutdowns and a collapse in oil prices.  However, on the day, oil is up as Saudi Arabia raised crude prices for customers worldwide.  
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