The euro is ranked as the best performing G10 currency against the US dollar over the course of the last two weeks after it broke through the 1.14 level on July 14 for the first time in over four weeks. The EU stimulus deal worth €750bn was the main driver for the euro’s initial surge after the leaders finally agreed on a response to pull the EU economies out of its worst recession in history.
Although the initial rally of EURUSD could be attributed to EUR-specific factors, arguably broad dollar weakness took over.
Yesterday marked the pairs second breach of a key level. The euro traded well above 1.17 against the dollar yesterday morning and has kept trading around its 2-year high in this afternoon’s session as US-Sino relations and a surge in virus cases in the US continue to dominate markets, weighing on the dollar.
Additional details on EURUSD drivers:
- EU Recovery fund. It took the leaders more than 90 hours of negotiations spread over five days, but the 27 leaders of the EU member states managed to agree on the composition of the fund. The main reason for why the negotiations took so long was the disagreement on the sizes of the grants and loans. When it was announced that the leaders agreed on 390bn of subsidies and 360bn in loans, this sent two messages to markets. Firstly, the fund is incredibly important in drawing the shape of Europe’s revival as it is supposed to rescue the EU’s hardest-hit economies from the economic turmoil of the pandemic. Countries like Spain, France and Italy have probably suffered a far greater economic shock due to the severity of the outbreak and the necessary restriction measures to contain the virus. Secondly, the mere fact that the EU finally agreed on a plan bodes well for the euro outlook given that the market has overcome a large downside risk factor – the agreement signals cohesion in the European Union. This should help keep yields on riskier European government debt, issued by Italy for example, in check.
- Broad dollar weakness. The US dollar has been weighed upon substantially by its domestic outbreak and political risks. Net virus cases rose by about 465k last week, while confirmed deaths posted the largest 1-week increase since early June. US-China tensions are flaring up again with President Trump repeatedly accusing China of failing to control the virus, as well as espionage, human rights violations and intellectual property theft. Increased US-Sino tensions and rising virus concerns weigh on risk appetite ahead of Wednesday’s FOMC meeting while the latter raises the likelihood of a more prolonged US economic recovery. Whereas usually dampened risk appetite bodes well for the dollar, the greenback’s safe haven appeal has faded in the current environment due to the risks being isolated to the US economy. On Wednesday, the Federal Reserve is likely to enhance forward guidance at this meeting while postponing more aggressive measures such as yield curve control to a later stage this year. The current “whatever it takes” mandate for asset purchases still holds, and so does the Fed’s likeliness to signal that it will continue with its dovish monetary policy stance for now.
US new virus cases around highest levels since beginning outbreak while cases in Europe stabilised
There are clear potential downside risks to a stronger euro. Spain, France and the Netherlands have recently seen a spike in virus cases, which increases the risk of localised lockdowns. Such an event would slow down the recovery of those nations. Friday’s GDP data will be highly crucial in drawing the shape of the eurozone’s revival and provides a snapshot of the relation between the economic indicators that have been released in Q2 and the actual level of economic output. In addition to this, the EU fund is yet to be ratified. The proposal has to pass the European Parliament and has to be ratified by the individual member states. The working assumption in Brussels is that the ratification process will only be completed at the beginning of next year. Although the nations agreed on the distribution and conditions of the fund for now, there still is a risk involved as the ratification requires unanimity. On the other hand, additional monetary easing at the margin by the FOMC on Wednesday could spur the recent wave of USD weakness further.
While we don’t expect the Fed to announce yield curve control or a negative interest rate policy at this meeting, the risk still remains.
Additionally, a continued deterioration in the southern states ability to contain the domestic outbreak could result in further lockdown measures being implemented which would in turn lead to further USD weakness. On the whole, however, we see the balance of risks tilted to the downside in the short-term.
EURUSD rips over 4 percentage points higher in July and reaches 2-year high
Author: Ima Sammani, Junior FX Market Analyst