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- EUR pops as Saudi Arabia seen close to restoring lost oil output.
- And as U.S. Fed battles against surging interbank funding costs.
- But Rabobank and UBS tip EUR to hit new lows before year-end.
- EUR downgraded at Rabobank, bearish view reiterated by UBS.
- Weak growth weighs on EUR as trade war lifts USD into year-end.
The Euro rebounded out of an earlier trough Tuesday but is set to hit a new low before year-end, according to strategists at Rabobank and UBS, who say European Central Bank (ECB) interest rate policy, a weak Eurozone economy and the U.S.-China trade war will all weigh on the single currency.
Europe's unified unit surged higher during noon trading Tuesday after Reuters reported that Saudi Arabia is close to restoring almost all of the production capacity knocked out by an alleged Iranian drone strike at the weekend. The move came around the same time the Federal Reserve Bank of New York said it would pump $75 bn of new money into the U.S. interbank lending market in order bring down funding costs for banks.
Overnight funding costs had risen as high as 10% in the Tuesday session as a range of factors were reported to have drained the market of crucial Dollar financing, which helped support the greenback through the trading session only for the Fed's intervention to be attributed some of the blame for pushing the U.S. currency lower and the Euro higher later in the day.
"It seemed strange that EUR and GBP led the FX bounce against the dollar yesterday. The move seemed to come after the Fed announced the overnight repo operation. We don’t think the EUR has a lot going for it right now, but if the dollar edges lower/slides on renewed QE from the Fed today, EUR/USD will go along for the ride. Above the 1.1080/1110 area, EUR/USD could push to 1.1200," says Chris Turner, head of FX strategy at ING.
Fed intervention to reduce bank borrowing costs and lower oil prices are both Euro-supportive factors. Saudi Aramco is said to be on the verge of getting 70% of its lost capacity back online and expects to have all the 5.7 mn barrels in lost output restored within weeks, rather than the "months" initially mooted.
The Abqaiq processing facility and Khurais oilfield were damaged this weekend, which resulted in the loss of around 6% of global output and sent oil prices rallying by double-digit numbers in a price swing that stoked fears for the global economy. Europe, with its economy on renewed life-support measures from the European Central Bank, was especially vulnerable to an oil-induced spike in inflation that suppresses already-low GDP growth across the bloc.
Above: Brent Crude oil futures price shown at daily intervals.
"The EUR has been the most vulnerable so far in the G10 (along with INR in EM). We think this reflects three set of factors: the overall changing USD/oil correlations, the nature of the oil move ('supply' vs 'demand') and the broader macro environment. Ultimately we believe it helps rather than hurts USD," says Vassili Serebriakov, strategist at UBS.
Brent crude oil futures prices were up 15% for the last month and 26.15% for 2019, trading around $65.96 per barrel, earlier on Tuesday but have since beaten a retreat from those levels. Analysts are now waiting with bated breath for the U.S. and Saudi response, after both countries accused Iran of having been behind the attack, which is now the single greatest risk to prices since Saudi Aramco is expected to get its production facilities back online promptly.
"EUR/USD has been trading even weaker than some of the recent correlations suggest, which could indicate an unwind of post-ECB tactical longs. We have been sceptical of that post-ECB move because the EUR remains as a deeply negative carry currency that is mainly driven by weak domestic growth at the moment. We maintain our 1.09 target with downside risks," Serebriakov says.
Above: Euro-to-Dollar rate shown at hourly intervals.
Rising oil prices are an ongoing risk for the Euro but are not in any way essential to the current bearish forecasts being pushed by Rabobank and UBS, who say the Eurozone economy, ECB rate policy and the U.S.-China trade conflict will be the most important influences on the Euro in the months ahead.
Serebriakov flags last weeks decision by the ECB to cut its deposit rate further below zero as a significant headwind for the Euro. The decision has made the Euro an even more attractive "funding currency" because negative rates make it cheap to borrow. His idea is that investors will use it to finance bets on other currencies by borrowing the Euro, selling it on the market and buying the desired higher-yielding alternative with the proceeds.
"There is plenty of reason to remain cautious. It would appear likely that even if a deal is reached in the next few weeks that this will be far less comprehensive than the agreement that was pursued in May," says Jane Foley, head of FX strategy at Rabobank. "Differences will remain between the US and China beyond October. This raises the risk that any additional boost to risk appetite which could weigh on the USD in the coming weeks will run out of steam."
Above: Euro-to-Dollar rate shown at daily intervals.
U.S. and Chinese negotiators are expected to hold talks next month that are aimed at de-escalating the trade war between them, and Chinese officials are said to be propositioning the White House with another offer to buy agricultural goods ahead of the meeting. They're also reported to be pitching a 'mini deal' that addresses some U.S. concerns over trade practices in return for relief from new tariffs expected to be imposed in the middle of October and December.
Both sides have this month rolled out exemptions for some products that were targeted with fresh punitive levies barely a month ago, leading markets to believe a deal that ends the damaging tariff fight between the world's two largest economies could be close. However, many analysts have expressed reservations about the odds of a lasting truce being reached any time soon, including Rabobank's Foley. She says the current market optimism about the U.S.-China outlook should wear off by year-end.
"The EUR remains one of the worst performing G10 currencies on a one month view and in light of the economic clouds over the German economy we expect the EUR to remain under pressure vs. the USD into the end of the year as optimism about what could be a mini-trade deal wears off," Foley says.
The trade war has hurt the Chinese domestic economy and with it, demand for goods made in German factories, especially luxury cars. And with the rest of the global economy also weakening rapidly in response to the tariff fight throughout 2019, the German manufacturing sector has fallen into recession and is threatening to take the entire economy with it. Germany now faces the prospect of slipping into recession just as it's contending with a 'no deal' Brexit and a direct trade conflict with the U.S.
Above: Euro-to-Dollar rate shown at weekly intervals.
"Germany’s manufacturing sector is already widely considered to be in recession and fear of a no-deal Brexit has been exacerbating this risk. Worries that Trump could re-set his sights on trade with the EU are another particular concern for Germany," Foley says. "There are fears that the US Administration could slap tariffs on all imported cars and car parts by mid-November on the basis that these are a threat to national security."
November marks the end of a 180 day exemption for European car exports from new U.S. tariffs that are intended to be a retaliation for "unfair" trading practices. President Trump announced and then delayed the tariffs in May to facilitate negotiations with the EU, although the White House wants European car tariffs cut to the same level as those of the U.S and for American farmers to be given access to the protected European agricultural market.
The latter would be a politically incendiary move for some EU members so has always been seen as unlikely, although many analysts also doubt the U.S. would start a tariff fight with the EU. Nonetheless, the prospect of a trade war erupting is tipped by Foley to weigh on the Euro over the coming months and so too is a foot-dragging Federal Reserve (Fed), which is yet to cut its interest rate my a meaningful enough degree to deter investors away from the Dollar.
"The Fed is widely expected to cut rates at the September 19 FOMC meeting and, if this coincides with optimism about US/China trade talks the Fed may have some impact in weakening the USD near-term. That said, in our view the pace of Fed rate cut is unlikely to accelerate significantly until the H2 2020," Foley says. For this reason we are not expecting EUR/USD to convincingly break its downtrend until next year. We expect EUR/USD to be trading in the 1.10 area on a 6 month view."
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