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Speedy market shifts have defined trading during the pandemic era. On Wednesday it was the turn of the euro to grab the limelight, with the single currency climbing beyond its year-end forecast against the dollar to $1.14, based on estimates compiled by Bloomberg. Wednesday’s move reflects the perils of forecasting, particularly in the currency realm and at a time when a considerable amount of uncertainty swirls.

Here you can see how year-end forecasts for the euro dipped from $1.16 in January towards a recent low of $1.12, before rising to $1.14 in July.

Line chart of $ per €, spot rate and consensus forecast for end year showing Euro runs ahead of forecasts

The single currency has enjoyed quite a bounce of late — like many others — from its March low ($1.066), powered by very aggressive Federal Reserve actions. These include slashing overnight interest rates, effectively capping long-term Treasury yields via quantitative easing and forward guidance, while expanding dollar swap lines with global central banks.

All these policies have duly weakened the US dollar and revived one of the big macro calls for the 2020s — the end of a bull run in the world’s reserve currency. A key question is whether the current euro rally is a head fake or the start of a more substantial shift.

A key driver of any big dollar selling trend is a firmer euro, given the importance of this currency pair in foreign exchange trading. After a period of being stuck between $1.12 and $1.14 (since early June) and while commodities — led by iron ore, copper and gold have surged — the euro is within sight of its early-March intraday spike beyond $1.15.

In the near term, traders will keep a close eye on whether those intraday peaks are breached. After a run above $1.145 earlier on Wednesday, the single currency pared back some gains.

Among pending important eurozone events, the central bank meeting on Thursday is eclipsed by the gathering of EU leaders on Friday.

Bank of America describes the backdrop for the currency market in these terms:

“The market is long euro, but positioning is not stretched. Absent a communication mishap (from the ECB), the focus will be on the EU summit.”

Clearly, signs of even incremental progress on the EU’s proposed €750bn coronavirus recovery fund on Friday should help sustain enthusiasm for the euro and its longer-term prospects.

George Saravelos at Deutsche Bank has been steadfast in calling for “a big broad dollar turn” and expects the euro to climb towards $1.20 this year, adding that the “consensus is too conservative on the euro”.

Such a call, in part, reflects the relatively smooth reopening of European economies versus the more protracted process in the US. And for all the holes in Europe’s recovery fund, George makes this important point:

“The recovery fund is not just about economics but the impact it has on confidence.”

That will translate into funds flowing into eurozone assets, buoying demand for the currency, highlighted by this snapshot of exchange traded funds via Deutsche Bank.

Daniel White at Canada Life Investments thinks sentiment is “definitely looking up for the euro”, given how during its existence “there has been a perennial worry about the sustainability of the eurozone”.

Another driver of currency markets has been moves in interest rates. The recent shifts in real yields — adjusted for inflation — highlight the pressure on the dollar versus the euro. The five-year Treasury real yield has fallen beyond minus 1 per cent after starting the year just above zero. The US benchmark is also nearing a German five-year real yield at minus 1.09 per cent. The bond and currency markets suspect the US benchmark may well head further south and perhaps test the 2012-13 lows of about minus 1.8 per cent.

A weaker reserve currency is seen playing a crucial role in stemming global deflationary pressure. That suggests little let-up in easy policy from the Fed in which real yields start rising, as they did during 2013. This period, known as the taper tantrum, was triggered by the central bank signalling the end of QE at the time.

Now some do worry that the end of temporary employment support in the US and UK in the coming months represents another type of taper that could spark a bout of market turmoil. Any round of risk aversion of course does bolster the dollar, so this remains a wild card for markets.

But the chance of this remains slim given the actions already taken by governments and central banks, and a backdrop of policy action that has been set over the past 12 years.

Daniel at Canada Life reminds us:

“The story for some time has been whenever there is any form of market distress, central banks and governments step in.”

Quick Hits — What’s on the markets radar?

The euro is not the only asset breaking higher. Stronger risk appetite is highlighted by the Australian dollar pushing beyond US$0.70, with US West Texas Intermediate holding above $40 a barrel.

Brad Bechtel at Jefferies notes:

“The commodity market just does not stop surprising markets with powerful moves in iron ore and copper the past several weeks and now this huge draw on the oil market. [It] corroborates the recovery story but doesn’t quite jive yet with the high-frequency data flatlining and virus resurgence story.”

Among leading US banks, Goldman Sachs has usually demonstrated its prowess in navigating volatile trading conditions. Second-quarter revenue for its fixed income, currency and commodity division more than doubled from the same period in 2019, arriving at $4.24bn versus $1.7bn, the best performance in nine years. Net income of $2.42bn for the year was unchanged from a year earlier. 

From here, the performance of FICC looks a lot more challenging in the absence of any renewed market turmoil. During the earnings call, David Solomon, Goldman’s chief executive, noted:

“The activity levels that we saw at the end of March and April were really extraordinary, we’ve not seen the same level of activity over the course of the last five or six weeks.”

Tourism is an important industry for many countries, particularly for the developing world. The Institute of International Finance notes:

“High-frequency data for the first six months of the year suggests a decline in arrivals close to 100 per cent in many places.”

The IIF believe:

“The return of growth in China should support tourism in Asia earlier than in other regions, while eastern Europe will probably benefit from the reopening of borders as well as EU support.”

In contrast, the path of recovery looks tougher for others such as Latin America. IIF adds:

“Across EM, the tourism sector is heavily reliant on SMEs [small to medium enterprises], which may find it more challenging than larger enterprises to survive.”

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I’d love to hear from you. You can email me on michael.mackenzie@ft.com and follow me on Twitter at @michaellachlan.

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