Euro-Dollar Rate Aided by Economic Figures, More Substantive Recovery Eyed in 2020

Image © Alfred Yaghobzadeh, European Commission Audiovisual Services

- EUR outlook aided by better economic figures and U.S.-China truce.

- Services stabilisation eases fears over domestic economy.

- German factory orders bounced in Sept, recovery sighted.

- Eurozone retail sales grow faster than expected in Sept.

- MUFG eyes scope for a 2020 rebound in growth and EUR.

Sentiment towards the Euro was aided mid-week after data suggested Eurozone growth might be ready to finally turn a corner after a difficult year. The Eurozone's services sector shone in October, with a reading of 52.2 being reported, against consensus expectations for a reading of 51.8 to be reported.

Eurozone retail sales rose 3.1% year-on-year in September, well ahead of the 2.5% forecast by markets, a number that could mean there's upside risk to current estimates for Eurozone economic growth heading into year-end.

The German factory sector was subject to positive news after German Factory Orders read at 1.3%, ahead of the 0.1% forecast by markets. The German Services PMI was revised higher to 51.6, up from 51.2 in the preliminary estimate, while

The services number, if the beginning of a recovery, could suggest that risks to the domestic economy from the downturn in manufacturing may have been overstated of late while the factory data suggests the latter may now be coming to an end. 

"These are encouraging numbers, insofar as goes the fact that the trend in year-over-year growth appears to have stabilised, albeit at a depressed rate of around -5-to-6%," says Claus Vistesen, chief Eurozone economist at Pantheon Macroeconomics. "Retail sales data support the story of a relatively robust domestic economy... add to this still-solid growth in services spending, and the picture is one of steady growth in consumers’ spending."

Above: Pantheon Macroeconomics graph showing correlation of factory orders with industrial production.

Germany's factory sector has fallen over in the last year and is widely thought to have dragged the country into a technical recession in the third quarter, although the final word will not be said on that question until Thursday 14 October. 

Any sustained turn higher in the new work orders figures could portend a recovery in the broader economy, which would be good for the Euro because the German boat is a large part of the Eurozone flotilla and has an impact on the buoyancy of many others in the bloc too. 

Manufacturers responding to the latest Leibniz Institute for Economic Research (Ifo) survey were less optimistic about their current situation in October but did become more positive in their views for the next two quarters, which was credited by the institute as stabilising the broader economic outlook. But with the U.S.-China trade war having ebbed significantly of late, there could be more upside ahead for German factory orders.

Tuesday's data helped put a lift the Euro-to-Dollar rate off the floor that was established overnight and in the wake of Tuesday's solid Institute for Supply Management (ISM) services PMI in the U.S., which helped dispel fears of an imminent crunch in the world's largest economy.

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

Euro Recovery in 2020 Driven by Easing Trade War Tensions

While data has certainly been supportive of the Euro, the single-currency has not appeared to register any sustained lift on the back of the data.

It remains the case that currency markets remain more concerned by the dynamics of the global trade war than the domestic picture; indeed this makes sense if some of the downturn in the Eurozone has roots in the trade war.

"The conflict clearly impacted euro-zone growth more than US growth as given the importance of external demand to Germany and the positive impact in the US from Trump’s domestic tax policies," says Derek Halpenny, European head of global markets research at MUFG. "De-escalation of the trade conflict, if it happens, could well see some repricing of euro-zone assets. The speculation of the US not implementing the auto tariff is already having an impact." 

President Donald Trump was reported this week to be considering cancelling some of the tariffs imposed on imports from China back in September, just days after Commerce Secretary Wilbur Ross said in an interview the White House might decide against imposing punitive levies on imports of cars from Europe. Both are goods news for the Eurozone economy, the fragile condition of which has forced the European Central Bank (ECB) to resort to further monetary policies that are handicapping the Euro.

The White House reiterated at the weekend its focus on finalising a 'phase one deal' agreed in principle with China on October 11 that has already averted one tariff increase and that could yet prevent a new round of U.S. tariffs being imposed on imports from China on December 15. Trump is thought to be keen to put the trade war on hold at least until after the November 2020 election so if a deal is firmed up over the coming weeks it could help augur a European economic spring some time next year.

"There are many episodes when yield diminishes as an influence in FX direction and if we were to see some compelling evidence build of a better relative macroeconomic picture for the euro-zone versus the US then there are grounds for EUR to break from the current rate differential influence," Halpenny says. 

Above: EUR/USD at daily intervals with negative difference between DE and U.S. 2-year bond yields (orange line, left axis).

An August-through-September escalation of the U.S.-China trade war may have been the final straw for the ECB, which cut its deposit rate further below zero and announced a new quantitative easing (QE) program back in September as it sought to fight the disinflationary force of the slowdown by stimulating the economy with lower borrowing costs. The problem is that was possibly the last bullet it had left after years of battling crises and lacklustre inflation.

With the Federal Reserve (Fed) having called time in October on the short 'mid-cycle adjustment' that saw it cut its interest rate three times this year, U.S. borrowing costs and bond yields are still among the highest and most attractive among the major currencies for now. This is partly because the gap between yields in the U.S. and Europe remains so wide that even a 2019 turn higher has not yet been enough to tempt investors away from the Dollar and back toward the Euro. But MUFG's Halpenny says this could change soon, as the tide of economic growth momentum eventually turns in favour of the single currency.

"We recently published a euro-zone outlook piece that points to some modest pick-up in real GDP growth in 2020. This could happen at a time of further deceleration in US GDP growth, and with pessimism so high in Europe, we don’t see that scenario as priced. More data like the Sentix Index (biggest jump in 10yrs) earlier this week would help diminish some of the pessimism that would help EUR/USD even given the yield spread disadvantage," Halpenny wrote, in a note to clients Wednesday. 

Halpenny and the MUFG team tip the Euro-to-Dollar rate to finish the year around 1.1150, slightly above Wednesday's levels, but forecast it will rise gently to 1.15 by the end of September 2020.


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