| Eurozone PMIs, which were released overnight, showed a sharp rise in economic activity in March. This was driven by broad-based growth across PMI components and regions. While the improvement in data reflects a better-than-expected recovery, the timing of the survey (March 12–23) means that the recent rapid deterioration in the COVID-19 situation and subsequent extension and/or tightening of restrictions in Germany and France are not fully reflected in these numbers, which opens up the possibility for downward revisions.|
For now, the outlook for the U.S. economy is clearly better than the outlook for the eurozone economy. Not only did the U.S. economy experience a recession that was only half as bad as the recession in the eurozone, but it also has a brighter outlook.
There are three main reasons why this could be the case: much stronger fiscal policy support in the U.S. compared to the eurozone, much more effective Fed communication compared to the European Central Bank (ECB) and persistently slow COVID-19 vaccinations in Europe.
Starting with fiscal policy, fiscal stimulus in the U.S. this year will be three times the size of the EU Recovery Fund, which will be spent over the next seven years, with the bulk of spending coming in 2023–24. Moreover, with the U.S. expected to pass an infrastructure package later this year in the $2–$4 trillion range, fiscal support in the U.S. could reach up to six times more than the EU Recovery Fund, depending on the details and possibly higher taxes. Additionally, the reintroduction of EU fiscal rules next year could bring austerity in Europe.
As for monetary policy, the Fed’s communication this week was much more effective and more dovish than the ECB’s last week, as illustrated by the markets’ reaction. The Fed was able to surprise markets to the dovish side despite a substantial upward revision to its forecasts. In contrast, the ECB confused markets with a new, complicated and vague terminology.
Finally, the latest COVID-19 developments in the eurozone have been concerning. Despite lockdown measures, infection rates have increased again, leading a number of European countries to tighten measures. In contrast, the U.S. is seeing falling infection numbers, with states continuing to reopen. Europe is also lagging on the vaccination front, with only 11% of its population inoculated compared to 35% in the U.S. and 39% in the U.K. The European Medicines Agency reaffirmed the safety of AstraZeneca’s vaccine, leading to countries resuming vaccinations after a brief suspension. However, the concern is that people will remain reluctant, putting Europe even further behind its peers in the vaccination race.
This all nets out to a bearish medium-term EUR/USD profile as a much stronger recovery in the U.S. provides support for the dollar. Even under its new flexible average inflation targeting (FAIT) regime, the Fed remains data dependent. As such, the central bank should turn more balanced as the year progresses and U.S. data continues to improve as projected. If anything, massive fiscal support skews the risk to an overheating economy that would complicate the policy normalization process.
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