31 Oct 2018: Euro Facing Multiple Headwinds

Euro Facing Multiple Headwinds

October 31st: Highlights

  • Italy, Germany, and Monetary Policy driving single currency lower
  • Budget row over “little extras” rages on
  • Dollar supported by “relative strength”

Euro facing very bumpy ride

While it is too early to be considering sounding the death knell for the Eurozone, there are significant long-term negatives building up which will need serious statesmanship and delicate negotiation if the whole project is not to collapse.

Brexit has shown that the prime negotiation tactics of those at the top in Brussels consist of “our way or the highway” and hiding behind treaties that were signed at a different time and with different intentions.

Italy has become sufficiently radical under its nationalist government to threaten the very fabric of the growth and stability pact which binds the Eurozone together financially. Brussels really has no answer to any Italian refusal to amend its 2019 budget since Rome has chosen to ignore the three-week ultimatum it has received and will carry on with its implementation. If Brussels uses “Brexit” tactics and sticks to the rules, it can only exacerbate the situation.

In Germany, the announcement of the departure of Angela Merkel as Chairman of the CDU following December’s leadership election and her decision to stand down as Chancellor in 2021, will leave not only a vacuum in German politics but the EU will lose an almost irreplaceable advocate for change and progress.

The continued dovish outlook for any change to monetary policy from the ECB, which is fully justified by recent data releases, is a further headwind for the euro. The commencement of withdrawal of additional stimulus has had no beneficial effect on the currency and a tough period is now fairly certain.

Yesterday the single currency managed to stay above its year’s low, reaching 1.1338 and closing at 1.1344. With monetary policy in the U.S. set to be tightened again in December the widening interest rate differential will be a drag on the euro for some time to come.

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UK Budget criticised from several quarters

The UK Parliament, no doubt grateful to have something other than Brexit to consider, has been arguing over whether the Chancellor’s Budget, delivered on Monday, really does mean an end to austerity.

As ever in politics, it is the words rather than the deeds that are being argued over. The opposition’s criticism over the lack of funding for local government and the police have been overshadowed by an argument over the use of the term “little extras” when announcing the provision of extra funding to schools which may be used to fund additional equipment purchase as a one-off payment. The budget will be passed as the Government will lean upon the support of the DUP MP’s when it comes to a vote.

The one major caveat that emerges from the budget is the assumption that there will be a satisfactory deal struck between London and Brussels that enables the proposals to be executed. That is far from certain in the current environment and the FX market continues to vote with its feet.

Sterling fell to 1.2695 yesterday versus the dollar and closed just ten points from the low. It remains under pressure, despite the current negatives, primarily, in a similar manner to the euro, due to the disparity between growth and monetary policy between the UK and U.S.

Dollar shrugs off elections as growth provides support

There is a growing feeling in the market of a fracture between politics and the economy in the U.S. that continues to provide support for the dollar. With the midterm elections looming large, it is the employment report that will be released on Friday that is driving short-term optimism.

Fed Chairman Jerome Powell has made it clear that the FOMC is concentrating on economic activity as the driver of monetary policy and it is hard to imagine a scenario next week that will derail that course, despite the Democratic party becoming even more likely to win the House of Representatives, wresting control from the Republicans.

Assuming a Democrat victory in the House of Representatives, the Senate takes on greater significance with polls predicting less than a 30% chance of a Republican loss.

The dollar index briefly breached the 97.00 level yesterday, reaching a high of 97.02 before closing at 96.99. Overnight, it has remained close to that level and has made a new year’s high at 97.07

Market expectations for the employment report remain for there to have been 200k new jobs created this month together with a significant adjustment to September’s weather affected number of +137k. Wage inflation is expected to have breached 3% again and this should allow the dollar to continue to climb.

Have a great day!

About Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”