Where next for the battered EUR?

The dollar index has gained over 1.6% this month already, as worries over the spread of the coronavirus have boosted demand for the dollar, amid uncertainty over the global outlook. The buck is attracting haven flows, especially as the impact on US activity is likely to be more modest than the effect on Europe, given the openness of its economy. We’ve already seen estimates that the virus will shave 0.2% off Germany’s Q1 GDP, which means it will quite probably experience a technical recession during the winter.

Remember that the dollar does well against the euro when risk appetite is strong and megacap stocks are marching higher, as the single currency is used as a funding currency in these circumstances. On the flip side, with the reported cases of coronavirus rising today, risk assets should be on the back foot, which means more dollar upside.

Europe flatters to deceive

For the beleaguered eurozone, the fall in EUR/USD has been ongoing since making cycle highs at the end of last year at 1.1239. Aside from the outbreak of the coronavirus, the hope for many was that Europe would pick up on the reflation trade and begin to outshine US financial assets. Alas, this has been dashed with relative data surprises noticeable recently; for example, the shocking French and German industrial production which was significantly worse than expected and further dampened expectations that Europe’s downturn is on the mend. Money markets are now pricing about six basis points of ECB easing by year end, versus zero probability a few weeks ago.

Hopes for a turnaround

Next week’s European PMIs may offer some relief, with a move further from September’s trough of 50.1 signalling growth and slightly better prospects in Q1. The question is to what extent export prospects to China’s economy will be hit, which may scupper such hopes. Visible Chinese easing or a Fed signal of more rate cuts would of course help euro bulls, but this seems some way off for now.

Otherwise, we wonder when President Trump embarks on more Twitter jawboning, having recently been critical of the level of the dollar – “tough” on US exports – he said. A ‘soft ceiling’ could be hanging over the overbought USD, but we may need to get nearer the October highs around 99.67 in DXY to see this.

Technically, it wouldn't be a surprise if 1.12 turns out to have been the high of 2020 in EUR/USD. The most recent COT report shows sentiment is increasingly bearish on the euro with the biggest bets since last October. A decisive break of major 1.0877 support is needed to see further declines, with the next support of note at 1.0810 (the ‘Macron gap’ from April 2017). Although all short-term momentum indicators are oversold, only a move above 1.0950 would indicate the weakness in the euro has run its course.