As seen on:
ntv-logo sky-logo comedy-central-logo

Euro – exactly how ‘over-valued’ is it? Or was it?

  • Euro weakness to USD has been a notable trend for 2019
  • Price action is reaching a point where continuation of the trend might be confirmed – or not.

The euro is continuing its year-to-date downward movement against the USD with its trading channel now well established.

EURUSD – Price chart – Year-to-date:

Source: TradingView

According to Investing.com, the daily ‘technicals’ continue to indicate further selling pressure.

Investing.com – EURUSD Pivots resistance and support – Daily:

Source: Investing.com

The EURUSD five year chart includes the 50% and 61.8% Fibonacci lines, which are seen to no longer form support but actually resistance. More downward pressure.

EURUSD – Five year price chart:

Source: TradingView

The two questions raised are – where is all this selling pressure coming from and how long will the trend last? Are we at one of those moments where the market consensus – as the euro is overvalued – is so strong that it ironically signals the moment it is over-sold?

 

Fundamental weakness

The German economy recently suffered two body blows. On Monday, the Bundesbank, Germany’s central bank, warned that “economic performance could again decline slightly” in Q3 (source: Yahoo! Finance). This would mark the economy contracting for the second quarter in succession and denote Germany to be technically in recession.

On Friday, Deutsche Bank cut its German growth forecast for 2019 and believes Germany is already in recession. Stefan Schneider, Deutsche Bank’s chief economist sent a note to clients saying:

“We see Germany in a technical recession, as we expect another 0.25% GDP drop in Q3.”

Source: Yahoo! Finance

Official reporting is relatively light this week, but even without the benefit of cold hard data, the markets have known for some time about the slowdown in the eurozone. The bad news has been surfacing since Q4 2018 when there was another contraction in the German economy. The data isn’t great, but nor is it surprising. So it raises the question – to what extent is it already priced into the USDEUR price?

 

The ‘bend at the end’?

There are of course factors that could at least halt the downward trend, and maybe reverse it. Given that the underlying health of the eurozone is unlikely to experience a rapid and significant uptick, those wondering what the catalyst for a reversal might be are instead looking to geo-political events.

 

China 

MarketWatch has produced an interesting report, which considers the influence of the eurozone and EUR upon the US dollar/Chinese yuan currency war. Noting the recent devaluation of the yuan, analyst Houze Song suggests the risk of EUR becoming embroiled in the conflict is one reason the yuan devaluation has stopped where it has. A cross reference to previous yuan devaluations, including the one from 2018 notes the movement to the new level has typically been more gradual but also more marked, usually a movement in the area of 8%. The opinion being that if you are going to manipulate your currency you may as well do it ‘properly’. The recent devaluation is about one half of the usual size.

Source: BBC

Song’s analysis notes:

“A more meaningful check on yuan depreciation is the harmful impact it will have on exports from the European Union and Japan. That in turn could prompt these two powerful economies to align with the United States in the ongoing trade war with China. Beijing knows full well that it cannot win a multi-front trade war and will want to prevent that from happening.” 

Source: MarketWatch

Any yuan depreciation against the US dollar will likely translate into even larger depreciation against the euro. This is due to a ‘triangulation’ between the currencies and because unlike the US central bank, the European Central Bank has limited ability to cut interest rates. The ECB has interest rates already around zero, so should the USD and yuan go through further rounds of competitive devaluation against each other, the EUR will be left high and dry.

Any relative strength from the EUR against the yuan would decimate already weak eurozone export figures.

 

Brexit

The Brexit process is generating a lot of noise at the minute. It’s not too contrarian an approach to consider the apparent discord as a necessary part of a proper, engaging and therefore potentially successful negotiation process. The May-Juncker proposal was drafted by bureaucrats and failed to withstand exposure to the reality of political process. The failure of that Working Agreement has brought about the possibility of a more binary course of action. The threat of no-deal has to date brought more pressure to bear on GBP than EUR but has been a drag on both currencies. There is a lot of road to travel, but it does appear that some kind of deal might appear, which would be a fillip for both the UK and eurozone economies, and both sterling and the euro.

GBPEUR – Year-to-date price chart:

Source: TradingView

 

Where next?

Writing on Monday, Dmitriy Gurkovskiy considers the argument that the euro may continue to slide unless there is some kind of political intervention. Trading at 12 month lows against the USD certainly opens the door to the downside. Gurkovskiy references German press reports on the weekend as being the most likely provider of support at these levels:

“The euro might have plunged evermore, but was surprisingly ‘saved’ by Der Spiegel, a German weekly news magazine, which wrote that the German government was ready to settle for the budget deficit if the country’s economy started falling into a recession. This was pretty unexpected and unusual because Angela Merkel and the German Federal Ministry of Finance have been famous for their tough stance against any economic incentives related to budget and tax policies.”

Source: FX Empire

Such a move would be another unexpected event to come into play in the forex markets. It could be added to the list that includes the yuan pegging being done above $7 and the Reserve Bank of New Zealand choosing to shave a full 50bps off interest rates.

The analysts at FX Empire offer further thoughts (not to be construed as trading ideas) on future price action.

Source: FX Empire

“On H4 EURUSD has formed a figure of the downtrend continuation. The centre of the structure is explicit around 1.1130. The minimum of the figure at 1.1090 is broken away. There is a potential for the continuation of the third declining wave to 1.1010. The goal is local. After that, a correction to 1.1070 may happen, followed by a decline to 1.0980.”

Source: FX Empire

FX Empire stresses its note is not intended as trading advice. Taking the EURUSD’s movement in a downward trading channel, it is a time for the curious to watch if the trend continues or if we are at the ‘bend in the end’. It’s an interesting situation but one best watched from the sidelines.

When the People’s Bank of China and rather reverential German press start throwing curve balls, there is a feeling that things may be beginning to get out of hand. The normally ‘dull’ guys are managing to start a commotion and doing so quite successfully with limited help from the US president. Should President Trump find time for some more middle of the night tweets, volatility could pick up even more.