The pressure has seemingly been taken off the European economy with the announcement of bold policy objectives from the G20; and a smaller than expected ECB rate cut has once again left the forecast for the Euro Zone interest rates at an advantage to many of its global counterparts. This seems to be the ideal outcome for the euro; but is this really the case? To really gauge the euro’s strength, we have to consider the general level of risk sentiment in the market, the potential for unseen threats to the regional economy and the likelihood that the central bank will be able to avoid the desperate policy efforts of their US and UK counterparts.
Euro Strength Dependent On Outlook For Risk And Interest Rates
Fundamental Outlook for Euro This Week: Bearish
- ECB cuts rates less than expected, leaves the dour open for further cuts
- Euro area inflation cools and German joblessness rises – entrenching the regions recession
- The euro has yet to forge new highs. Read the Technical Weekly report for a different view of the market
The pressure has seemingly been taken off the European economy with the announcement of bold policy objectives from the G20; and a smaller than expected ECB rate cut has once again left the forecast for the Euro Zone interest rates at an advantage to many of its global counterparts. This seems to be the ideal outcome for the euro; but is this really the case? To really gauge the euro’s strength, we have to consider the general level of risk sentiment in the market, the potential for unseen threats to the regional economy and the likelihood that the central bank will be able to avoid the desperate policy efforts of their US and UK counterparts.
Before considering the euro’s position on the spectrum of currency market strength, you need to first have a feeling for the general mood in the market. Sentiment seems to be improving and has been for the past few weeks. However, this isn’t finding much support from growth and expected return forecasts. Recession has seized the global economy and even conservative estimates see the slump extending at least into the second half of the year. This means, that speculative capital finding its way back into the market (from money market accounts, government debt and other relatively ‘risk-free’ assets) will require a very high level of safety and returns that can compensate for risk that will likely remain elevated for quite some time. The euro will struggle to make the grade on both fronts. For returns, the Euro Zone seems to have a leg up thanks to a 1.25 percent benchmark rate. However, this primary rate doesn’t have the same flexibility that its Australian and New Zealand counterpart have to further lower rates - should economic and financial conditions warrant it - and still come out with an attractive yield advantage. ECB policy officials clearly see the disadvantage of rates near zero, but they are running out of options and time. In his public address, President Trichet suggested the current rate was not necessarily a floor and that the central bank would announce its decision on pursuing unusual policy tools next month. This may include quantitative easing, purchasing additional private debt or any other number of possibilities; but for the euro trader, it will mean conditions in the Euro Zone are just as bad as they are in the United States and United Kingdom.
It will take time and many exogenous fundamental shifts from within the Euro Zone and the broader market for the larger fundamental themes described above to play out; but in the meantime, event-driven traders will still have a hearty round of economic releases to work with. Immediately diving into the health of the financial markets, the forward looking Sentix Investor Sentiment gauge will offer a look at confidence from a group that is the most economically educated and directly vested group in the entire economy. The expected rebound comes after record lows and wouldn’t include the influence that the G20 statement had on the crowd however. Also from the Euro Zone, we have the retail sales and final 4Q GDP reading. Both are lagging indicators; but they will stand as a reminder of what conditions the economy is truly in. the German docket offers the more interesting mix. Trade figures have been somewhat overlooked recently, but Europe’s largest economy (and the most vocal against extending its fiscal stimulus) may change its tune to injecting more aid into its economy if its still-strong trade links diminish and exacerbate anemic domestic demand. Factory activity and orders will further offer a good leading indicator on the likely trend in general growth, employment and trade. Most of the European markets will be closed Friday for the Good Friday holiday. - JK
