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Market Analysis

EURUSD Goes High, But Eurozone Remains Sluggish — What Happened?

June 01, 2018
BY Emma Richards

Between US President Donald Trump’s threat of trade wars on Twitter, European Central Bank (ECB) President Mario Draghi’s inflation confidence, and the unstable geo-political situation in Syria, EURUSD closed at 1.2321 by the end of the US session on Monday — a jump of 0.31%.

Looking ahead, Draghi remains confident about eurozone’s inflation prospects and predicts that it will rise in the coming days. However, uncertainty remains over the degree of economic slack. Draghi also feels that the recent stock market slide has not had a significant impact on broader financial conditions. As such, ECB expects the pace of economic expansion to remain strong in 2018. Furthermore, Draghi said that while ECB remains confident that inflation will converge towards the aim over the medium term, there are still uncertainties about the degree of slack in the economy. As such, a patient, persistent, and prudent monetary policy remains necessary to ensure that inflation will return to the ECB objective.

ECB Vice President Vítor Constâncio, too, is optimistic about increasingly strong and broad-based eurozone economic momentum. However, pessimism about inflation persists for him, as it remains largely subdued. Constâncio expects inflation to rise only gradually over the medium term.

ECB sees both eurozone GDP and inflation (CPI) to reach around 1.9% by December 2020. However, Constâncio warns that ECB should be cautious that early restrictive policy (normalization) could derail inflation recovery as inflation has not yet completely responded to what ECB wishes to see.

In short, Draghi’s views about eurozone’s inflation prospects conflict with that of Constâncio’s. However, Draghi’s sentiments proved more influential to the market, causing EURUSD to jump to a day high of around 1.2330.

ECB’s Chief Economist Peter Praet also agree with Constâncio about the muted eurozone inflation. He too sees the subdued nature of inflation developments and that, going forward, monetary policy will evolve in a data-dependent way. Praet further points out that there appears to be a disconnect between growth and inflation, and that ample degree of monetary policy stimulus remains necessary.

Elsewhere, ECB’s Benoit Coeuré stresses for more ECB action for achieving the elusive 2% inflation target. Although he believes that the pace of growth in eurozone is not slowing per se, ECB still needs to do what it can to raise inflation to 2%. Coeuré also points out that ECB will soon discuss asset buyback timing (QE tapering). The overall outlook, however, doesn’t warrant a change in monetary policy stance.

Thus, it is now clear that although ECB is quite confident about the sustainability of eurozone’s economic growth, the same cannot be said about its inflation prospects.

Wage growth and inflation, too, remain a mystery. The answer to the eurozone inflation mystery may lie in the globalization, automation, and other structural factors, such as unfavorable demography, ageing, and the fact that the labor market is still not tight; i.e. the supply for labor, for example, far outweighs the demand for jobs that do not require specialized skills. As a result, general wage has not grown as much as expected. Huge unemployment numbers in parts of eurozone may also be the reason why people are accepting jobs with lower but stable salaries.

Meanwhile, the International Monetary Fund (IMF) echoes the above mentioned structural reasons for muted wage growth and falling labor force participation. As such, IMF prescribed some potential solutions, including: more education, more flexible immigration policies by developed/advanced economies, as well as more public spending on early childhood education and care, flexible work arrangements, and parental leaves. Parental leaves, in particular, may attract more women to join the labor force. Furthermore, IMF recommends reduced incentives for members of the workforce to retire early.

Eurozone economic data was muted:

On Monday, eurozone’s economic data proved to be subdued. German exports for February fell to -3.2% from the previous -0.4% against an estimate of 0.2%; imports fell to -1.3% from the previous -0.2% against an estimate of 0.3%. Finally, German trade balance was down to USD 19.2 billion from USD 21.5 billion against an estimate of USD 23.1 billion.

Notably, the German exports suffered the biggest decline in over two years, while February imports saw the biggest decline in eight months. These subdued German trade numbers may be the result of a stronger EUR, as well as the ongoing trade war rhetoric by President Trump.

Although Germany has not been directly impacted by President Trump’s threats, the country has been indirectly victimized all the same. The current state of global trade conflicts revolve mostly around China and the US. However, Germany could become the first prominent victim outside of these two countries. China has announced its plans to impose a 25% import tariff on cars produced in the US. This may harm Germany because they happen to be the largest car manufacturer and exporter the US.

While the prospects for the German export machinery have deteriorated significantly in recent weeks, the present state of the economy gives further reasons for the concern. Sentiment indicators and industrial data were weak at the start of the year. In fact, January and February’s performances have been the weakest since 2009.

Meanwhile, eurozone’s April Sentix investor confidence fell to a 14-month low of 19.6 from 24 in March — that’s weaker than the expectation of 21.2. This points to another soft patch for eurozone economic data.

Technical View (Positional):

Technically, whatever the ECB and Trump narratives are, EURUSD now needs to stay above 1.23600 for a further rally to 1.23900-1.24200 and 1.24600-1.25000. Otherwise, sustaining below 1.23500, it may fall to 1.23000-1.22150 and 1.22050-1.21500 in the coming days.

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