The EUR/USD Outlook May Be Turning for the Better after ZEW Survey Reveals "Green Shoots" of Recovery 

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- EUR softens in face of stronger USD but outlook brightens.

- ZEW survey shows 6-month Euro growth expectations recovering.

- Prompting talk of "green shoots" and forecasts of EUR renaissance.

The Euro was weaker in the face of a stronger Dollar on Tuesday but the outlook for the single currency may have brightened this week after the influential ZEW survey revealed what economists have described as "green shoots" that point to recovery in Europe's largest economy. 

The German ZEW indicator rose to 3.1 in April according to the Leibniz Centre for European Economic Research, up from -3.6 previously, when markets had looked for it to reach only 0.9. The Eurozone measure rose from -2.5 to 4.5 when markets had looked for a reading of only 1.2.

"A strong ZEW index alone will not solve the current mystery of what the real strength of the German economy actually is. In our view, however, it is another welcome green shoot. After a long series of downward revisions of German growth prospects, it could be time for first (tentative) upward revisions," says Carsten Brzeski, chief economist at ING Germany.

The ZEW is a German survey that asks 300 financial experts for their opinions on various questions relating to the markets and economy. Participants are asked about the current situation as well as their six-months expectations concerning the economy, inflation rates, interest rates, stock markets and exchange rates.

All of the April increase came as a result of an improvement in the outlook for the economy over the next six months, because investors' assessments of the current economic situation actually deteriorated again in April. 

The current situation index fell -5.6 points during April, to just 5.5. Meanwhile, the six-month economic expectations index rose by 6.7 points to 3.1 this month.

"The German economy remains a mystery. Driven by a series of one-off factors, the German industry was all of a sudden in a free fall in the second half of last year. A free fall, which had not been predicted by any leading indicator," Brzeski writes, in a note to clients. "At the same time, however, the domestic part of the economy has remained stubbornly strong."

Above: Euro-to-Dollar rate shown at hourly intervals.

German GDP growth fell sharply in late 2018, with the economy contracting by -0.2% in the third quarter and stalling with 0% growth in the final quarter. The decline was driven by a downturn in the industrial sector, with manufacturers right at the heart of it. 

There is no singular cause of the downturn that gets a unanimous vote from economists although many potential factors have come under the spotlight including the U.S. trade war with China, which hurt the economy last year, as well as the ongoing Brexit process which could see some German companies shut out of their largest market. 

Official first-quarter economic figures will not be released until May but the European Central Bank (ECB) has already said that 2018's economic slowdown almost certainly carried over into the New Year, prompting the governing council to abandon plans for a 2019 interest rate hike. 

"We can safely ignore the falling current situations ZEW index as long as the expectations gauge are climbing. Indeed, a positive divergence between the two usually is a bullish indicator. The ZEW and the Sentix investor surveys are frowned upon, but they often get the direction of the more widely watched IFO correct, and they’re currently pointing to another increase in next week’s report for April," says Claus Vistesen, chief Eurozone economist at Pantheon Macroeconomics

Eurozone growth fell to 0.2% in the third quarter of 2018, to 0.1% in the final quarter, which took annual GDP growth down from 2.3% to 1.8% last year. The ECB said in April that growth probably slowed even more in the first quarter and that inflation could fall further over the coming months. 

This matters for the Euro because the bank needs faster economic growth in order to get the consumer price index and core inflation back toward the target of "close to but below 2%". It can't lift interest rates in a meaningful manner until inflation can sustainably hold the target level.

That might take quite some time but the Euro may not have to wait for an inflation recovery before it is able to win back lost ground from the U.S. Dollar.

Above: Euro-to-Dollar rate shown at weekly intervals.

Analysts said this week that a likely slowdown in the U.S. economy this year will increasingly have markets speculating about Federal Reserve rate cuts and should help lift the Euro-to-Dollar rate later in 2019. 

"It is important how the US’ outperformance gap closes, if US growth crashes, it could still be good news for the USD because of the dollar smile, but the US has remained resilient - and perhaps Trump’s deregulation will keep it so. The green shoot narrative is therefore probably also supportive of a bounce in EUR/USD, but so far, we have only opted to highlight that scenario," says Martin Enlund, chief FX strategist at Nordea Markets. "At some point one though must put the money where the mouth is and hence we go long EUR/USD."

Enlund has a target of 1.1650 attached to his trade idea and a stop-loss set at 1.1187. Technical studies from Bank of America Merrill Lynch also support the idea of Euro recovery in the short-term. The bank says a "double-bottom" may have formed on the charts and the market might rise even higher than Enlund has projected. 

 "We can see a double bottom pattern forming since EURUSD rallied off last month's post ECB lows. Such a rally has formidable resistance to break in the mid 1.13s (trend lines and cluster of moving averages) as well as the March peak at 1.1448. We look for price action to further validate our view this month," says Paul Ciana, a strategist at Bank of America. 

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