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The Euro-Dollar Rate Gets No Joy From Industrial Bounce as Tariff Fears Linger, Risk Aversion Rises

© Gage Skidmore

- EUR softens in risk-off market after industrial production surprise

- Production rose in Sept when markets foretold another contraction.

- But uncertainty over U.S.-China talks, EU car tariffs weighs on EUR.

- Trump's speech in NY prompts questions about trade war outlook.

The Euro was softer against the Dollar and other major currencies Wednesday even after industrial production data surprised on the upside for the month of September, as fears over U.S. trade policy kept investors in a risk-off mood and tempered appetite for the single currency.

Eurozone industrial production rose 0.1% in September when markets had been looking for a 0.2% decline, which confirms the message from revisions to earlier data that had made clear to investors that the continental industrial downturn was not as severe as once thought in the third quarter. 

Wednesday's figures showed output still falling in Germany, Spain and Italy but rising in France, Ireland and other countries. The headline rate is said to have been boosted by the result for Ireland, which was particularly strong, although the data have done little to boost expectations of GDP growth in the quarter. 

Above: Pantheon Macroeconomics graph showing Eurozone manufacturing PMI alongside industrial production.

"The silver lining, albeit a small one, is that growth is no longer in free-fall, but seems to have stabilised at a depressed pace. If this is sustained, perhaps even with a slight upturn in H1, base effects will soon turn positive for the quarter-on-quarter rate. Finally, these data won’t move the needle on tomorrow’s second Q3 GDP estimate. We think the advance headline will be confirmed, and that real GDP in the EZ rose by 0.2% quarter-on-quarter, the same pace as in Q2, with the year-over-year rate dipping by 0.1pp, to 1.1%,"says Claus Vistesen, chief Eurozone economist at Pantheon Macroeconomics. 

Markets are waiting to hear if Germany really did fall into recession in the third quarter, while also looking to see if the Eurozone's already-reported 0.2% expansion is confirmed. The continental economy has slowed sharply in the last year due to the effect of the U.S.-China trade war, the threat of White House tariffs hitting EU exports and uncertainty over Brexit. New EU regulations in the automotive sector have done their fair share of damage too. 

With a weak economy and subpar inflation pressures already having forced the European Central Bank (ECB) to test the limits of what interest rate and other monetary policies can do for an economy, investors and economists are keen to see signs of an economic pickup that would prevent the ECB from having to resort to further unorthodox measures in order to reflate the Eurozone economy. Inflation has been below the "close to, but below 2%" target for years now. 

Above: Euro-to-Dollar rate shown at hourly intervals alongside EUR/JPY rate (orange line, left axis).

"Industrial production data for September - while nothing to cheer - could have been a lot worse, US data for this week have yet to flow through, and lower USD yields could also hinder weakness in the pair. We'd much rather look to sell the pair north of 1.1075. FX investors should be mindful of the fact that US yields could have further to fall if "risk-off" persists, and that this will weigh on the USD vs the JPY and other major currencies," says Stephen Gallo, European head of FX strategy at BMO Capital Markets

There have been signs that Europe's economy could be on the verge of turning a corner, with factory orders figures for the month of September pointing to brighter days ahead in 2020 for the mighty German manufacturing sector. Short-term growth rates for German industrial production have already turned higher now that official estimates of earlier production levels have been revised higher and some influential surveys have also pointed recently to better days ahead. 

"That we did not sell off on Monday might be solely down to the fact that the US was on holiday. The euro did stop just shy of the 1.0990/00 area yesterday and bounced mildly off it, so that remains the near term level we are looking at. In any event, price action remains dull and uninspiring at best, and the better reading on future expectations in the ZEW survey was not enough to stimulate even a hold of levels let alone a turnaround," says the J.P. Morgan FX sales desk, in a client note Wednesday.

Any more signs of a pickup lurking in the long grass of 2020 might be welcomed by a Euro that's been battered and bruised by a dire domestic story and litany of international risks this year but the single currency was deprived of benefit from Wednesday's figures by a risk-off market mood following President Donald Trump's speech to The Economic Club of New York late on Tuesday. 

Above: Euro-to-Dollar rate shown at daily intervals alongside EUR/JPY rate (orange line, left axis).

"Many countries charge us extraordinarily high tariffs or create impossible trade barriers.  Impossible.  And I’ll be honest: European Union — very, very difficult.  The barriers they have up are terrible.  Terrible.  In many ways, worse than China. We’re working on legislation known as the United States Reciprocal Trade Act, meaning quite simply: What’s good for them is good for us.  If they want to charge us, we charge them. It’s a very simple thing," Trump said.

There was speculation Trump would announce a further delay of a decision on European car tariffs, as well as provide an update on the China talks, but he actually tempered the market's optimism that a 'phase one deal' to end the trade war could soon be reached when he repeated that he won't strike any agreement unless it's the right one.  

"Donald Trump's recent speech has been largely disappointing. The US government gives the impression of not being seriously interested in a partial deal with China. Thus, safe-haven currencies remain fairly attractive. The trade conflict remains a mystery for the markets as the respective strategies of both governments are hardly transparent. Hence, this leads to an ubiquitous uncertainty, as a re-escalation could be as imminent as an agreement," says Marc-Andre Fongern, a strategist at MAF Global Forex. 

Trump also criticised EU trade policy and its negotiating stance while omitting word of a tariff delay. The White House delayed for 180 days in May a decision on tariffs for European car exports pending the outcome of talks but Trump has since floated the idea of a 25% levy and the deadline to impose one or delay the decision is November 16. 

Risk assets have been buoyed in the last month by hope of an end to a tariff fight that's manufacturing sectors the world over on life support and crimped the global economic expansion. This was after Trump said on October 11 'phase one deal' had largely been struck and although the pact has already averted one increase in some tariff rates already applied to imports from China, the agreement is yet to materialise in writing or be formally entered into. 

White House language around the China talks has changed markedly in the last month. It's statements no longer claim that a deal has been reached while Trump said on Tuesday only that "A significant phase one trade deal with China could happen" before threatening that "If we don’t make a deal, we’re going to substantially raise those tariffs.  They’re going to be raised very substantially."

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