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- EUR aided by car tariff reprieve but downmove not over yet.
- HSBC eyes risk of new low as EUR must now also carry the ECB.
- Others eye losses from trade war, China's ill health, CNY correlation.
The Euro was trading higher against a soft Dollar and range of other rivals Monday but the downmove in the Euro-to-Dollar rate is not yet over, according to analysts at HSBC, who say the trend for the currency will remain to the downside over the coming months.
Europe's single currency benefitted from improved sentiment at the start of the new week after President Donald Trump confirmed Friday that tariffs on imports of cars from Japan and the Eurozone would be delayed for up six months.
The decision provides the single currency with clemency from levies that would simply have served to worse the economic headache faced by the European Central Bank (ECB), and comes at a time when the U.S. is believed to be preparing for a protracted tariff fight and economic conflict with China.
But analysts at HSBC say significant risks to global economic outlook and the fact the ECB is close to having run out of policy bullets it can fire in order to get the Eurozone economy moving again, mean the Euro will need to depreciate over the coming months in order to support growth.
"EUR-USD’s failure to bounce on a likely delay of auto-sector tariffs highlights underlying concerns for the single currency. The direct downside for EUR-USD if tariffs were eventually implemented would likely be relatively contained. But a lack of policy flexibility as the economy remains weak points to persistent EUR-USD depreciation," says Dominic Bunning, a strategist at HSBC.
The White House had been expected to impose a tariff of up to 25% on cars imported from Europe and Japan last Friday but late in the day, President Trump delayed the implementation of the tariffs for up to six-months and instructed the U.S. Trade Representative to enter fresh negotiations with the EU.
It's far from a foregone conclusion that the talks will eventually culminate in a deal, escpecially as the U.S. has insisted on a trade agreement that includes access to the EU agricultural market coming from the talks.
The latter is a political hand grenade given the large European agricultural sector that risks being exposed to competion from the U.S. And not only that, EU trade negotiator Cecilia Malmstrome has a mandate that permits her to only discuss "a limited trade agreement that includes cars".
Above: Eurozone car exports as percentage of total, manufacturing PMIs. Source: HSBC Research.
"The direct negative impact of tariffs on EUR-USD is likely to be modest. While EUR would weaken mechanically should any tariffs be put in place, the scale would be limited as FX flows from goods trade in EUR-USD are swamped by financial flows. As such there was little need for the pair to recover on the lack of tariffs. The bigger issue for the EUR is the underlying weakness of the economy, particularly the health of the manufacturing sector," says Bunning.
Bunning told HSBC clients Monday that U.S. tariffs on EU cars would have only a modest direct impact on the economy, which is a sentiment that's been echoed by many other analysts. But this is still a problem because of the potential second-order effects such a move might have on an already-weakened Eurozone manufacturing sector.
European manufacturers, particularly the German ones, fell into recession in 2018 after U.S. tariffs hurt the Chinese economy. There is an extensive economic connection between manufacturers in the Eurozone and China, with growth in one often depending on growth in the other.
And now, with the U.S. and China gearing up for a protracted tariff fight that risks turning into an all-out economic conflict, the outlook for Eurozone manufacturing has darkened again. However, the domestic side of the economy remains buoyant and is helping to keep the Eurozone growing for now, albeit at a reduced pace.
"The “Trump doctrine” of US foreign policy is clearly seen as USD positive by the market at present. That corresponds to the textbook doctrine that the currency of an economy that unilaterally imposes import tariffs appreciates (as I have explained in the past)," says Ulrich Leuchtmann, head of FX strategy at Commerzbank.
Above: Euro-to-Dollar rate shown at daily intervals.
The Euro-to-Dollar rate was 0.05% higher at 1.1159 during the morning session Monday but is down -2.6% this year, while the Euro-to-Pound rate was -0.06% lower at 0.8760 and has fallen -2.5% in 2019.
"EUR/USD continues to come off the 55 day moving average at 1.1243. Failure at the 1.1177 March low on a daily chart closing basis put the 1.1110 April low back on the map. Be advised that as long as 1.1110 holds, though, the pattern being traced out is a potential large bullish reversal pattern," says Axel Rudolph, a technical analyst at Commerzbank.
Above: Euro-to-Dollar rate shown at weekly intervals.
"Markets are jaw-droppingly stable, given significant escalation at the weekend of measures against China’s Huawei, in addition to signs that China’s leadership is digging in for a longer confrontation with the US rather than giving in to the latter’s pressure," says John Hardy, chief FX strategist at Saxo Bank.
Both German and Eurozone economies were expected to build in the coming months, on economic gains made in the first quarter, after slowing sharply in the second half of 2018. But the outlook has grown much more uncertain of late.
Eurostat estimates the Eurozone economy grew by 0.4% in the first-quarter, up from 0.2% at the end of 2018. But the inflential ZEW index pointed in May toward a further loss of economic momentum during the months ahead.
It's no coincidence that this fall in optimism among financial market analysts came at the end of the week that saw the White House lift tariffs on $200 bn of imports from China to 25%, from 10% previously. The ball is also now rolling on a process that could see another $300 bn of Chinese goods hit with a 25% tariff.
"The chart plots EUR/USD against the difference in consensus GDP forecasts for the US and Eurozone in 2019 and 2020 (courtesy of Bloomberg). An uptick in US 2019 consensus growth forecasts make this chart look ominous for the euro, at a time when relative rates and yields are doing nothing," warns Kit Juckes, chief FX strategist at Societe Generale.
Above: Euro-to-Dollar rate alongside Eurozone and U.S. economic growth differentials.
The U.S.-China tariff fight now risks becoming an all-out economic conflict because the White House is no longer relying on tariffs alone in order to pressure the Chinese into agreeing a deal that ends the country's "unfair trading practices" and alleged theft of intellectual property from foreign firms.
President Trump has placed China's Huawei, which is a national champion in the field of telecoms and related equipment, on its 'entity list'. This is a type of trade blacklist that could prevent U.S. and allied firms from supplying Huawei with parts and from using its products in their own goods.
Hu Xijin, who is Editor-in-chief of the Communist Party-sponsored Global Times and often seen as an unofficial spokesperson of the government, called this an act of "barbaric suppression" and speculated the government is devising a list of retaliatory targets.
"If USD/CNY heads purposefully towards 7, I doubt EUR/USD can avoid a break below 1.11 this week, " Juckes warns, in a note to clients Monday.
The USD/CNH rate that reflects the U.S.-China exchange rate has a negative correlation with the EUR/USD rate, which means if the former rises then the latter will often fall. And markets are speculating that the USD/CNH rate will rise from 6.94 to 7.0 over the coming weeks and months.
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