News & analysis

Having surged 5% since the November’s lows, we anticipate the EURUSD rally to extend into 2021, with a large proportion of the move to occur in the first half of the year on vaccine optimism and plans to re-open economies.

While we note that markets have already traded off news regarding the release of vaccines, much uncertainty remains around their distribution, their effectiveness against new strains and the timeframe for economies to reopen.

This meant that the EURUSD rally hasn’t been entirely idiosyncratic and has instead been a result of broad US dollar weakness in Q4. The weaker USD dynamic has been due to a confluence of factors impacting risk sentiment, including the reduced political risk following the Presidential elections, a dovish pivot by the Federal Reserve towards an Average Inflation Target (AIT), and the unwind of safe haven flows. We expect the [downturn in the dollar] to continue in the coming year and coincide with a robust eurozone recovery.

On the eurozone side, robust economic policies are likely to support confidence over a sustained recovery in economic activity. Actions by the European Central Bank to extend its Pandemic Emergency Purchase Programme until 2022, bringing the total PEPP envelope to €1.85tn, along with the ratification of the EU recovery fund are key to this view. After some hiccups in the process following a veto from Poland and Hungary, all EU leaders now signed the deal and the last step remaining is the European Parliament approving the deal of €750bn. The recovery fund, along with the expanded EU budget, which now totals €1.074tn between 2021-2027, places the eurozone in a favourable position as fiscal stimulus supports the recovery.

On top of our expectation for a sustained economic recovery in the eurozone in 2021, a global economic recovery in 2021 is likely to provide additional support for risk sentiment and, therefore, the euro. The procyclical nature of the euro means it is well positioned to benefit from a rebound in global growth as major economies begin to reopen at some point throughout the year. In conjunction with our view of a [weaker USD in 2021], the euro is therefore poised to continue its rally into 2021, however, risks to this view remain. While there are upside risks to our EURUSD view in the form of earlier vaccination and a stronger economic rebound, the downside risks remain and are substantial. These have been reinforced by the latest news of the Covid-19 mutation. While preliminary evidence suggests vaccines are still effective against the new strain, it highlights the difficulties the eurozone economies face in the New Year with respect to reopening.


Monex Canada FX forecasts 2021


Since our [previous forecasts], encouraging news around the clinical developments and success of the Pfizer and Moderna vaccines helped to give the euro and other G10 currencies a boost against the safe-haven dollar. This early optimism brought forward some euro appreciation in advance to what we previously envisaged, calling for an upward revision to our forecasts accordingly. We continue to expect extended euro appreciation in 2021, even though markets aren’t anticipating the vaccine to be distributed widely enough for economies to re-open in the short-term. For example, a poll by Goodjudgement’s superforecasters found that over half of the sample foresaw that FDA-approved vaccines will be ready to inoculate 200 million people in the United States by Q2 2021. Other investment banks and central banks alike have also based their economic forecasts for respective major economies on the premise that they will be able to reopen at the back-end of 21H1. Markets have already shown their willingness to look through short-term risks to this outlook when risk sentiment was largely unaffected by the resurgence of cases and the subsequent tightening of lockdown measures. This is likely to keep the euro trading at a high base heading into 2021. However, the latest news of a mutation in Covid-19 highlighted to markets that downside risks remain and that the previous price action based upon vaccine optimism can be reversed.

The deployment of robust stimulus packages in the eurozone has been a key factor behind the appreciation in the euro in 2020 and crucially supports our forecast of a stronger euro for the next year too. The creation of a joint debt market will allow some European economies to boost their weak credit profile while significantly reducing their financing costs. This initiative turns the European Union into a lender of last resort to its member states, setting historic precedent for the institutional strength of the bloc. Under this scheme, European-backed debt becomes an alternative safe haven investment for markets, similar to bonds backed by the US Treasury and the government of Japan. Considering that the EU debt market would be relatively small compared to those large issuers, European bonds could enjoy foreign demand resulting from the recalibration of international portfolios. The attractiveness of this instrument could favour the appreciation of the euro in a context of low relative returns on foreign assets with a similar level of risk. However, given that a large part of the capital flows captured by this nascent market could originate within the Eurozone itself (coming from the ECB, Germany and European private investors), the impact on the euro could be limited. Regardless, the supranational initiative offers a very positive signal to other European debt niches, by raising the institutional strength of the economic bloc to an unprecedented level.

Monetary policy efforts complement the effects of fiscal stimulus on the euro rally.

The expansionary strategy of the ECB, based on the Pandemic Emergency Purchase Programme (PEPP), has been a key step in reducing sovereign risk premiums within the Eurozone. The compression of public debt yields to record lows not only paves the way for economic recovery, but also mitigates the disparity of the effects the crisis has generated between sectors and member states. Thus, large economies such as Italy and Spain, which were severely affected by the pandemic, can take advantage of improved financing conditions. Moreover, the extension of the PEPP until 2022 for a total purchase volume of €1.85tn will allow the pace of weekly average purchases implemented to date to roll over for a relevant period of time. In addition, the flexibility of the long-term loan programme (TLTRO) increases the liquidity supply to the private sector, further boosting broad financing conditions. Despite the ECB allowing for some “optionality” on future monetary policy moves, the Bank’s forward guidance points towards an ultra-accommodative stance for a prolonged period of time in order to support the European recovery. This in turn, translates into a very supportive factor in the euro narrative looking ahead.


National debt markets reach record low yields after sound policy support

The ECB’s toolkit will be supported by the EU recovery fund, which should put a floor under risk sentiment. Additionally, earlier fears of a fiscal cliff in 2020 have been eased by national draft 2021 budgets from eurozone nations, which signal a broadly accommodative stance (4.6% of this year’s GDP), while additional support from the recovery fund should give the fiscal landscape a final push.

The EU recovery fund’s spending is expected to be frontloaded in 2021 and amounts to 0.5% of GDP in each year in 2021-2023.

A threat of a delay in the EU recovery fund arose when Poland and Hungary initially vetoed the plan on conditions of the rule of law. The headlines passed largely without too much impact on the euro as markets did not buy the story of the fund collapsing following a veto. A more likely scenario was that Poland and Hungary would be excluded from the deal. However, after German Chancellor Angela Merkel provided the nations with a detailed clarification on the rule of law provisions, both Poland and Hungary rescinded their veto. The Polish zloty and Hungarian forint enjoyed a mild boost on the back of this news, while gains in the euro were much more muted as the initial veto failed to shave off much of the earlier gains.


EURUSD remained within weekly range after EU recovery fund veto was lifted



The European Central Bank considers two different recovery scenarios: a mild and severe case, with markets arguably pricing in expectations tilted towards a milder scenario ensuing. The mild case includes successful containment of the virus, a swift roll-out of vaccines and limited economic scarring, with real GDP rebounding by 6% in the next year and reaching pre-crisis levels as early as the end of 2021. This scenario sees inflation rising to 1.5% in 2023. The severe case sees a delayed resolution of the health crisis with permanent losses to economic potential. Real GDP would see a marginal decrease in 2021, and 2023 GDP would be almost 2% below its pre-crisis levels with inflation being only at 0.8% in that year compared to the 2% target. It is worth noting that these projections were published in December, a week before Germany and Netherlands imposed more stringent lockdown measures with all non-essential stores shutting down along with the earlier closing of restaurants and bars. Many lockdown measures were in place already, however the latest restrictions will undoubtedly weigh on short-term GDP growth, with medium-term growth being reliant on a quick vaccine roll-out. Until then, sentiment is likely to be weighed down as restrictions will probably remain in place well into Q1 2021. Both Q4 and Q1 real GDP therefore are subject to downside risks.



Despite relatively limited damage to the unemployment rate in recent months, the labour market situation is expected to worsen further before normalising as the eurozone economy gradually gets back on track. Regardless, the true rate of unemployment is likely unknown in the eurozone, due to ample implementation of furlough schemes. With those receiving unemployment benefits not included on the whole in the unemployment figures, EU employment schemes have been some of the most generous among the world throughout the pandemic. Spain, Italy, Germany, France and the Netherlands all applied generous reduced-hour schemes and grants to smaller businesses and business owners. These measures likely prevented the eurozone labour market from collapsing. The rate of unemployment increased from 7.6% in Q2 to 8.6% in Q3, which is lower than what the ECB expected in its September projections. Downside risks to the labour market remain as long as restrictions are still in place and a certain level of economic scarring persists. As household consumption represents 55% of eurozone GDP, the performance of the labour market will have a massive impact on the recovery.

Despite the relatively milder impact on the labour market, the pandemic caused serious effects on savings patterns in the eurozone.

The savings rate is typically flat and stable, but surged to an all-time high of 25% in June this year, higher than most other developed regions, as the pandemic left many consumers concerned about the stability of their future earnings. Supply restrictions arising from the restricted services sector were partly responsible for these increased savings, but uncertainty about the economic outlook has made “precautionary savings” a theme in consumer spending patterns. Unlike the US, where the savings rate has retreated some 60% since its highest level, Europe still holds a high-savings profile despite favourable ECB-led credit incentives. While these savings could represent a strong source of growth in the recovery phase should consumers opt to release their funds in a flurry of demand, the persistence of protracted consumption and private investment could slow down the pace of economic rebound.


Eurozone saving rate surges to 25% as the pandemic builds up concerns around earnings             

Retail sales have picked up throughout Q4 despite the latest lockdown measures and in contrast with sentiment data around consumer confidence, such as the German GfK index. This should not be seen as a pickup in demand, however. Retail sales exclude services spending, which has been bearing the brunt throughout the pandemic and is still falling. Data shows that consumer confidence slipped from -6.8 in December (released in November) to -7.3 in January (released in December) following the surge of virus infections and the imposition of new restrictions in the area.


Growth in retail sales has accelerated sharply recently contrasts to weakness in consumer confidence



The euro’s recent surge is not yet sufficiently threatening the inflation outlook to trigger a further recalibration of the ECB’s monetary tools, in our view. Despite ‘jawboning’ by certain ECB members on the recent rise in the euro, the ECB has shown no real intention, nor interest, to cut interest rates further into negative territory.

The Bank doesn’t seem particularly concerned about the currency rally, even though, in theory, an excessively strong euro could counteract its reflationary efforts.

In turn, estimates by the Bank show that the pass-through effect of the exchange rate on domestic inflation is small and of little significance. This is due to producer prices being quite sticky despite the high sensitivity of imported intermediate good prices due to variations in the nominal exchange rate. The low relationship between the nominal exchange rate and domestic prices reduces the relative importance of the foreign exchange market on the ECB’s radar. Although the Bank always keeps “monitoring” the impact of the exchange rate on inflation, it is unlikely that the ECB will actively take part in currency depreciation beyond occasional verbal interventions. According to the purchasing power parity index measured through consumer prices, the euro is only slightly overvalued relative to its 10-year average real exchange rate.


Domestic inflation is barely elastic to nominal exchange rate variations



The recent surge in EURUSD at the back-end of November, which saw it breach the $1.20 handle, was accompanied by CFTC non-commercial futures positions. While non-commercial positioning data isn’t representative of the whole FX market, its data is timely, transparent and is generally a good gauge of market sentiment. Notably, the swing in positioning to net-long early on in the year predicted well the rise in EURUSD in 20H2. While net-long positions have been trimmed to some extent as EURUSD trades near multi-year highs, it hasn’t necessarily collapsed. This suggests that sentiment remains constructive on the single currency for 2021 – a view which is shared with our forecasts.


CFTC CME EUR Net Non-Commercial Futures Positions 


CFTC data provides one gauge of market sentiment around EURUSD. While we don’t have data on over-the-counter options, the price in which risk reversals trade – the spread between the price of call and put options – provides another relevant measure about how markets are positioning for expected EURUSD moves. Throughout the summer periods, markets progressively started to become aware that upside risks in EURUSD moves were starting to outweigh potential downside risks, especially in the short-run. 1-month risk reversals broke into positive territory in July and held there for the most part, suggesting many expected the EURUSD rally to continue in the short-run, which it did to a large extent. While near-term risks to the outlook have increased, evidenced by the drop in one-month risk reversals, as European nations implement tougher restrictions to combat the rise in case counts, vaccine optimism continues to keep longer-dated risk reversals steady in positive territory. This suggests that markets are protecting themselves against EURUSD upside risk on net over the 3M-to-1Y horizon.


Options markets turn bullish on the EUR as the medium-term outlook becomes clearer

However, markets aren’t just expecting a stronger EURUSD up to the 1-month horizon. The spread between 25-delta calls and puts remains positive for up to the 5-year horizon. This suggests that markets are expecting on average protecting themselves against a stronger euro throughout the normal length of the recovery stage.

While we make no claims of these markets being truly reflective of the market as a whole, especially as other dynamics such as FX hedging in portfolio’s and non-commercial drawdowns could be at play, they provide a strong indication of how market participants are potentially positioning themselves for a stronger euro in the coming quarters.


Options markets price near-term risks but overall narrative suggests upside risks to EUR outweigh downside risks

Pricing accurate as of 24/12/2020


Ima Sammani, FX Market Analyst
Olivia Alvarez Mendez, FX Market Analyst
Simon Harvey, FX market Analyst



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