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Macroeconomics

21 October 2019

EUR-USD Forex Dynamics 

At the end of September the EUR-USD cross rate had plunged below 1.09, but last week it seemed to be heading for 1.12. In October, the single currency has gained over 2% versus the greenback. So what has happened to change the picture? Or is this just a technical rebound? Time to take stock.

When talking about currency pairs, logically, there are always two sides to the story, just like a coin. In this case, there is something to say about the European and the US side of the coin. Starting with the latter, the past month has seen less punchy data compared to the past. Jobs growth is slowing and the latest retail sales data suggest the same. Industrial output also weakened and as a result of all this, investors are increasingly betting on more rate cuts from the Federal Reserve. On the back of this, the truce in the China-US trade war reversed some safety flows, which went into US Treasuries and obviously the dollar. More trade-exposed continents, like Europe, are less at risk if the trade war comes to an end.

Meanwhile in Europe, the European Central Bank’s monetary easing might have come to an end. The last rate cut and renewed quantitative easing have sparked some discord within the ECB. Outgoing ECB governor Mario Draghi might have overplayed his hand. Incoming governor Christine Lagarde will have to do some damage control before anything new can be decided, or so it seems. Getting all members aligned will take some time and hence a long pause looks highly probable. With one central bank done for now and the other not quite, the yield difference between money-market rates is narrowing. But also between Bund yields and Treasuries. Yield spreads are coming down, lending less support to the greenback. The bond curve has also been steepening somewhat faster in Europe, than in the US. That has given a boost to cyclical stocks and the banks, to which European equity markets are more exposed, compared to the US. Last week’s strong rally in Swedish capital goods stocks showed a decent appetite for more cyclical companies. The fact that international investors have been underweight in European stocks might have triggered some catching up with regards to their positioning. And of course, if a Brexit deal were found, there might be less risk buying into European stocks than was perceived before.

Whether short term or not, the single currency’s strength has some underlying fundamentals going for it. That said, dynamics for the currency markets tend to change all the time.