Euro facing several critical issues

Mario Draghi’s assertion that the Eurozone economy will start to pick up in Q2 driven initially by higher wages leading to an increase in inflation will be put to the test this week.

While inflation data for April beat expectations, activity data as measured by PMI indexes need to start showing some improvement for the market to be persuaded that the issues facing the region are cyclical, not systemic. France and Germany will report their manufacturing and services outlooks this week and the composite data for the Eurozone will also be released.

While the ECB continues to discount data released by individual members of the Eurozone, the financial markets look at Germany as a more reliable proxy for activity since the overall data often contain anomalies. Analysts anticipate a slight uptick in activity with manufacturing in Germany rising from 44.4 in April to 45 in May. While this continues to indicate a contraction in activity, it could be construed as the first sign of the expected turnaround.

The IFO institute form Munich will release its highly respected report on the German business climate this week. The Institute surveys more than 7000 businesses for their input on the business environment and for changes in their order books. This is also expected to report a slight improvement from last month.

Finally, European Parliamentary elections will commence this week, ironically kicked off by the UK which goes to the polls on Thursday. Most other EU countries will vote at the weekend. A rise in populism is expected but it is the degree of nationalism seen that will most interest Brussels.

The euro remains under pressure as traders await more concrete evidence of an improvement in the region’s economy. There is cautious optimism that that improvement may be seen this week. If traders are again disappointed, they could signal the end of their patience by increasing both the pace and volume of euro sales.

On Friday it fell to a low of 1.1154 versus the dollar, closing at 1.1158.

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May’s new, improved Withdrawal Agreement to woo MPs?

Following the breakdown of cross-party talks which had been trying to find common ground over Brexit, the UK Prime Minister Theresa May, has promised to put before Parliament an improved version of the Withdrawal Agreement. She hopes that this version of the Bill will accrue enough support to allow her to move to the next stage of implementation of the UK’s departure from the EU before leaving her position.

The main opposition Party, making political capital from the chaos rather than putting any serious proposals forward, has already said that it doubts that the new deal will be fundamentally different from the previous one, which has already been voted down three times, and as such, they cannot support it. They have also said that any without the promise of the deal being put to the people via a second referendum it will be rejected by them.

Economically, the UK is still performing reasonably when considered versus its trading partners but the fear that Brexit could boil down to a straight decision between no deal and no Brexit has spooked traders sufficiently for them to renew sales of Sterling. It fell to a four-month low of 1.2711 versus the dollar on Friday, closing at that level. It has continued to weaken overnight as stories in the weekend press pointed to a fractious election campaign for the leadership of the Conservative Party once Mrs May packs her bags.

Boris Johnson, the former Foreign Minister, is the favourite to lead the Party and his Eurosceptic credentials will lead traders to view no deal as a real possibility.

The EU elections which take place on Thursday with the results released on Sunday once voting has ended across the entire region. While the UK vote is superfluous in the current environment, the result for the newly formed Brexit Party will be heavily scrutinized to confirm whether it has a chance of becoming a force in the UK’s political landscape longer term.

Dollar index driven by risk outlook in the short-term

While the jury is still out on the progress being made by the U.S. and China in trade talks, traders are using the markets risk appetite to adjust their positions short-term. In the medium to long term, the Fed’s actions over short-term interest rates are the main driver for the market and therefore the dollar.

While the Fed remains reactive, it will be risk appetite and aversion that will be the main drivers. The dollar continues to hold onto its status as the most reliable safe haven although that position is threatened by the Japanese Yen and Swiss Franc, both of which have significant trade surpluses and stable interest rates to sustain them.

Recent speeches by Fed officials have expressed concern over inflation and interest rates in the U.S. They are concerned that should the economy start to falter the Central Bank may be left with little room to manoeuvre. That premise relies on the fact that the “new” economy that has been in place since the Financial Crisis has higher lows and lower peaks than had been seen previously.

While that question is impossible to answer given the fluidity of the global economy and the various drivers of differing significance, Fed Chair Jerome Powell clearly errs on the side of a continued expansion albeit at a slower pace than has been seen recently.

This week sees the release of the minutes of the most recent Fed meeting which despite being a little out of date by the time of their release, give a useful insight into the thinking of FOMC members which can be overlaid on events since the meeting.

PMIs (less significant in the U.S. than Eurozone) are also released this week as is data for durable goods orders.

The dollar index continued its rally on Friday as the euro and pound faltered. It reached a high of 98.03, closing within one pip of that level.