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The Euro-to-Dollar Rate Can Outperform Even as Coronavirus Outbreak Grows

- EUR/USD supported on charts with scope for outperformance.

- As coronavirus spreads across world and threatens economies.

- Wobbly emerging markets and crumbling stocks could lift EUR. 

- As investors exit carry trade bets on yield from brighter days.

- Virus foothold in Europe could temper performance, not can it.

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- EUR/USD Spot rate: 1.0874 down -0.05% today

- Indicative bank rates for transfers: 1.0498-1.0574

- Transfer specialist indicative rates: 1.0716-1.0781 >> Find Out More About This Rate

The Euro-to-Dollar rate was close to overcoming a key technical level on Wednesday that could relieve downward pressure on the exchange rate over the coming days, as some analysts tipped the single currency for outperformance if coronavirus further upsets global markets. 

Europe's single currency was trading around 1.0874 against the Dollar Wednesday, just inches from the 1.0879 threshold it needs to overcome on a daily closing basis in order to void some of the bearish signals given off by the charts in recent weeks.  And some analysts say the Euro should do just that this week, which would potentially open the door to a more protracted recovery. 

"EUR/USD is seeing embryonic signs of recovery from just above the 1.0763 2000-2020 uptrend. This is key support and we look for it to hold the downside and provoke reversal. Near term rallies will need to regain 1.0879 (the October low) as an absolute minimum in order to alleviate immediate downside pressure," says Karen Jones, head of technical analysis for currencies, commodities and bonds at Commerzbank

Jones says the Euro will face resistance at 1.0926 and 1.0981 but hasn't flagged any impediments to the single currency's effort to reclaim the 1.0879 level. She bough the Euro-to-Dollar rate at 1.0785 and 1.0834 over recent days and has told clients to target the 1.0975 and 1.1075 levels. 

Above: Euro-to-Dollar rate shown at 4-hour intervals.

"The news of Covid-19 spreading to South Korea, Italy and even a remote location like Iran has triggered a violent reset of investors’ perceptions of the potential consequences of this crisis. Up until last week, the fall in the daily number of new contamination cases in mainland China combined with additional stimulus helped developed equities print new highs. Markets are now pricing in the possibility of disruptions to economic activity and supply chains to be much more severe and longlasting," says Yves Bonzon, chief investment officer at Swiss private bank Julius Baer.

The Euro has rebounded handsomely off 2017 lows since last week as major economy  bond yields fell toward record lows while stocks markets and developing world currencies weakened amid mounting concerns over the spread of coronavirus, although losses in risk assets have accelerated this week after it became clear that the contageous form of pneumonia has well and truly established a foothold in Europe as well as a range of other countries. 

Negative European Central Bank (ECB) interest rates have made the Euro a popular 'funding currency' that sees investors borrow and then sell Euros in order to 'fund' bets on higher-yielding assets further afield. 'Carry trades" can result in the Euro-to-Dollar rate falling as stocks, commodities and emerging market currencies rise, only for the tables to turn as the apple cart rolls over.

This feature makes the Euro's behaviour similar to that of the 'safe havens' like the Dollar, Japanese Yen and Swiss Franc. 

"Commodity-linked EM currencies were already under pressure recently on the fallout from the coronavirus outbreak, but risk conditions are now even more broadly hostile for EM, even as we have yet to see a major adjustment in EM credit spreads. If the latter come under pressure, EM pain could intensify," says John Hardy, head of FX strategy at Saxo Bank. "Some of the lack of further downside has been due to a weak EUR and SEK funding currencies."

Above: Euro-to-Dollar rate shown at daily intervals alongside USD/JPY rate (red line, righthand axis).

"As a funding currency it makes sense to see the euro perform better in periods when investors are liquidating positions to reduce risk. So far this week, the euro is the 2nd best performing G10 currency," says Lee Hardman, a currency analyst at MUFG. "The key risk of this euro support not being evident would of course be if the COVID19 spread notably further within Italy or the euro-zone."

Households, companies, investors and governments over facing significant disruption to activity and a possible sudden stop of parts of their economies similar to that seen in China, where entire cities turned desolate as citizens went into isolation to avoid infection. TomTom data suggested traffic in the capital Beijing was 60% below its typical levels Wednesday, marking a deterioration from the 49% decline seen Tuesday. 

And drinks giant Diageo said that trade in countries near China "especially South Korea, Japan and Thailand" had been disrupted and that it could be April before the situation improves. It says this would likely cost amounts that are equivalent to around 1% of 2019 global sales and 5% of operating profit. Anglo-Australian mining giant Rio Tinto says it's "currently evaluating the impact" and that its products are still reaching customers.

"We recommend closing short EUR/CNH and long NOK/JPY (carry), ZAR/JPY (carry), ZAR/CHF (carry) and ZAR/EUR (carry) positions," says Alexis Chassagnade, an analyst at Julius Baer, on Wednesday.

Above: Euro-to-Dollar rate shown at daily intervals alongside USD/ZAR rate (red line, righthand axis).

"Austria, Spain, The Canary Islands and Croatia all reported cases suggesting high risks of further escalation in Europe. A worsening of cases in Europe won’t necessarily stop the liquidation of positions elsewhere funded by euro but it would certainly counter the outperformance of the euro that can be seen in periods of risk aversion," MUFG's Hardman says. 

Italy's government has said it's aware of 322 cases of coronavirus, up from zero last week, that now span almost half of the country's 20 regions although Lombardy and Veneto regions currently account for 283 between them. So far 10 patients have succumbed to the disease and one has recovered. Those are in addition to more cases in Japan, South Korea, Iran and others, while cases have this week been discovered in Austria and Spain for the first time. 

It's not known how the virus made its way to either of those countries but it clearly has and investors now have to confront the prospect of it disrupting Europe and other economies in the same way it has done with China. Although the ease with which individuals can travel across Europe, much of which is effectively borderless, could mean it has already spread beyond Italy, Spain and Austria and that national and international authorities are simply unaware. 

"Travel bans are one thing but how do you control for that when your borders are open? You ban a flight from China into Milan and the person will just fly through Frankfurt. So unless you do a China style border closing it will be a different containment strategy in the West than it was in China," says Brad Bechtel, a managing director of FX strategy at Jefferies. "One thing is clear, governments and central banks will move...governments may have no choice but to provide stimulus with this likely proving enough for even Germany to jump into the fiscal side. Italy already warning EU officials that budget targets are well out the door. If and when the virus issue passes we are going to end up in a world with a LOT more liquidity in it than we had even just 4 months ago."

 

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