EURUSD The Collapse Is Coming

Euro Dollar has edged higher over the week
Market sentiment is short-term Euro bullish
The early Monday bounce in EURUSD will not last, even if U.S. jobs data is poor
Europe looks to be in a deeper economic dislocation than the U.S.

The Euro has made up part of the ground conceded over the past few weeks from 1.0725 and yet has, as of now, failed to hold above the 1.1000 level. It topped out at 1.1016 on Friday.

Although much of Europe was closed for the traditional May 1 holiday, trading took the EURUSD rate higher for a third consecutive session, indeed it was the fifth gain out of six trading days. One reason for the push higher for the Euro was the weak tone in U.S. manufacturing.

Factory Famine

ISM Manufacturing PMI for the U.S. declined to 41.5 in April 2020 from 49.1 in March and was the steepest pace of contraction in the manufacturing sector since April 2009. Driving the decline was the slide in the New Orders sub-index that was booked at the lowest level since December 2008 and the Employment sub-index. That crashed to the lowest since February 1949.

When the week begins one may well see the Euro finding favour among the speculative community as the technical sentiment look good for Monday through Tuesday. Afterwards, the mood should become more Dollar friendly.

Figure 1: EURUSD Technical Sentiment Source: www.investing.com

The first part of the week will be shaped by a reflection that U.S. capacity utilisation at factories is a meagre 72.7%, the lowest rate of use since April 2010. To illustrate why the factory capacity is so underused just consider auto manufacturing. Production in this crucial sector of the U.S. economy decreased to 1.70 million Units in March from 2.62 million Units in February of 2020. Now wonder the purchasing managers in America are so gloomy.

The IHS Markit US Manufacturing PMI was revised lower to 36.1 in April 2020 from a preliminary estimate of 36.9, compared to March’s final 48.5. The latest reading was the lowest since early 2009, as output, new orders and exports all fell at record rates due to measures implemented to contain the COVID-19 outbreak.

Of course, as we look ahead to Friday, May 8 the focus will be on the state of the U.S. labour market. Non-Farm Payrolls for April are forecast at -21 million and the unemployment rate will scream higher to 16%.

Much of this has been anticipated and if the Friday data points for the U.S. are at these levels then the Dollar should be too heavily undermined.

Betting Against The Euro

Recent data has shown that the Eurozone economy retreated at the fastest rate in its history in Q1 2020 as GDP plummeted 3.8% in the first three months of the year compared to Q4, 2019. The expectation is that Q2 2020 data will be far worse.

Speaking at a virtual press conference following the central banks meeting, ECB President Christine Lagarde said the Eurozone economy could retreat by up to 12% this year.

To help provide more liquidity she announced that the central bank would ease the conditions on its “targeted longer-term refinancing operations”, known as TLTRO’s, so the interest rate is in effect -1%. However, such is the demand shock that monetary policy is, now akin to fighting though a liquidity trap i.e. the ECB is pushing on a string.

Of course, weaker credits, maybe even junk debt could be accepted as collateral when banks borrow from the ECB. Normally, that debt must be rated above a certain level by private-sector ratings agency like Moody’s or Standard and Poor’s (S&P). However, “normal” is not a word to be used lightly in the Eurozone as asset purchases have begat the greatest distortion of yield spread reality in history.

The minimum for “investment grade status” is S&P BBB-, Moody’s Baa3 and Fitch BBB-.

This is a measure to afford an accommodation to Italy. S&P credit rating for Italy stands at BBB with negative outlook, Moody’s credit rating for Italy was last set at Baa3 with stable outlook and Fitch’s credit rating for Italy was last reported at BBB- with stable outlook. Thus, Italy, the fourth largest Eurozone economy is on the brink of being classified as “junk”.

What is staggering is that Lagarde continually repeats the mantra that the ECB will do whatever it takes whilst she urges member states to do more with fiscal policy. So why then, will she not tear up the rule book and buy debt directly at auction. If the ECB does do this it is only a matter of time until a sovereign debt auction fails to be covered at acceptable rates.

I do not think the problems of the Eurozone will be solved as swiftly as those that confront the U.S. and as such, I am looking for the EURUSD to still trade lower with parity in sight this year.