Euro Cracks 1.10. Are More Gains Ahead?

Euro Cracks 1.10. Are More Gains Ahead?

Kathy Lien  | May 28, 2020 04:31

For the first time in nearly eight weeks, EUR/USD broke through 1.10. Since Germany and France first proposed their recovery fund, we’ve been talking about a more meaningful turn in the euro and have been looking for a break of this key level. Now that it happened, investors are focused on the upside, but further gains should be limited ahead of the European Central Bank’s monetary policy announcement next week. Compared to other central banks, the ECB has been less eager to lower interest rates in favor of their Pandemic Emergency Purchase Program, which central bank member François Villeroy described as a “masterpiece.” 
 
In the last 24 hours, we’ve heard from a number of monetary policy officials who all seem to suggest that more easing is on the way. This includes ECB President Christine Lagarde, who said this morning that its very likely the ECB’s “mild scenario is out of date” and the economy is likely between the central bank’s “medium to severe scenarios,” which means GDP could fall between 8%-12% in 2020. They are preparing their economic projections now and will release it at next week’s policy meeting. 
 
ECB's Isabel Schnabel was more blunt, saying the central bank is ready to expand tools to achieve its mandate. ECB vice-president Luis de Guindos said the central bank is totally open to recalibrating its stimulus program, while chief economist Philip Lane says the economic shock requires expansionary fiscal and monetary policies. 
 
Currently, the euro is riding on the coattails of an expanded recovery fund that would combine the German-French proposal with the proposals of the “frugal four,” including Austria, Denmark, Sweden and the Netherlands. This new proposal offers 500 billion in grants and 250 billion in loans. This compromise paves the way for funding to be approved and released by January 2021. While that may seem far away, this is exactly the type of fiscal stimulus the ECB has been calling for, albeit they would certainly like to see more. 
 
In contrast, sterling was the weakest currency today, falling sharply against the U.S. dollar and euro. Talk of negative rates continues to suppress the currency as the UK remains committed to a Dec. 31 Brexit, according to a spokesman for the UK prime minister.
 
Meanwhile, the ongoing recovery in U.S. stocks drove the greenback lower against all of the major currencies except for the Japanese Yen, which edged slightly higher. The Federal Reserve released its Beige Book report today and it was no surprise that it said economic activity fell sharply in most regions, resulting in sharp decline in economic activity. The outlook remains bleak because while “many contacts expressed hope that overall activity would pick-up as businesses reopened, the outlook remained highly uncertain and most contacts were pessimistic about the potential pace of recovery.”
 
The big story for the U.S. dollar and the market are ongoing U.S.-China tensions. The equity markets are completely ignoring that worry, but the Australian dollar is starting to pull back. President Donald Trump said he will announce “very interesting” action against China this week. Commerce Secretary Wilbur Ross said “there is a whole menu of potential options for Trump on China.” This includes sanctions on businesses, financial firms and officials, suspending Hong Kong’s special trade privileges for implementing a new law that curtails Hong Kong civil liberties. China thinks the U.S. is bluffing, but if Trump announces severe measures later this week, we could see a sharp turnaround in equities and currencies that could sap the rally in AUD and NZD.
 
USD/CAD traded lower for the third straight day despite lower oil prices. Loonie benefitted from the risk on rally but its gains should moderate for the rest of the week as we look forward to softer current account and GDP data.

Kathy Lien

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