Euro Goes into Freefall; Have Investors Become Too Pessimistic?

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The misery of the euro is only getting worse and worse. The single currency plowed more than one-year lows against the U.S. dollar and pound, and six-year lows against the Swiss franc. Expectations of divergent monetary policies have been heavy for some time, but now there are recent doubts about the growth outlook that are also worrying investors. The resurgence of virus cases in many parts of Europe has taken markets by surprise, jeopardizing the already fragile recovery of the eurozone. But whether the bearish sentiment is exaggerated, and whether investors overlook the risk of infections elsewhere follow in a similar direction?

Last in the recovery race

The eurozone economy has made solid progress in recovering from the pandemic by 2021, yet the euro has steadily declined against most of its major counterparts. The main explanation behind the lower yield of the euro is simple. With other major economies also either on or off the road to recovery, their central banks are making plans or have already begun to normalize monetary policy after an extraordinary period of unprecedented stimulus.

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The Federal Reserve recently joined the Bank of Canada and the Reserve Bank of Australia to reduce its monthly assets, the Bank of England could raise rates next month, while the Reserve Bank of New Zealand recently raised its exchange rate for the second time since the pandemic. . While it is true that the European Central Bank has also slowed down its bond purchases and will end its crisis QE in March 2022, it still has its regular purchasing program (APP) that was running at the same time during the viral crisis. It is widely expected that the ECB will not only keep APP active for the foreseeable future, but may slightly strengthen it to partially offset the conclusion of the emergency purchases.

More importantly, the ECB is not at all close to raising its benchmark lending rates, surpassed only by the Bank of Japan when it comes to delayed delisting. These expectations have gradually formed over the year, dragging euro crosses lower, but the bearish outlook has received additional thumbs recently.

A double blow to the euro

First, ECB leader Christine Lagarde doubled the Bank’s dovish stance, warning of premature tension. Lagarde is fast becoming the odd among central bankers who have yet to deviate from the notion that the current spike in inflation is temporary, even when most of her fellow politicians are adopting a more precautionary approach.

Second, Covid-19 infections are rising rapidly in many parts of Europe. Several countries have recently announced the imposition of some restrictions, with many targeted against unvaccinated people. But some nations have entered a partial or full blockade. With winter just started, the virus image could get much worse before it gets better. Although, as seen from subsequent confinements, businesses and consumers have learned to adapt to the developing viral situation, the latest measures are expected to damage economic activity in the coming months.

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The weaker growth outlook may only mean that there will be even less urgency for the ECB to raise rates in the coming year. And despite the fact that money markets will continue to price at a 10-point exchange rate, currency traders are not too convinced. Even if the ECB were to bring in tariffs, it would still be a miserable increase compared to the tension predicted by other central banks.

The return of confinements

So far, blockchain in a post-vaccination world has been something that has not been taken into account by investors and that may be why the latest sale of the euro has been so dramatic. After all, countries like Britain have led the way by proving that it is possible to keep low on Covid deaths while you repeal almost all rules of social distance. So why are some European nations with stricter borders than Britain being inundated by an increase in hospitalizations due to Covid?

There is some evidence to suggest that the AstraZeneca sting, which is responsible for most of the UK’s vaccine doses, provides better protection for the elderly. Another possibility is that there is greater herd immunity in the UK due to higher previous infections, in particular, the Delta variant spread there much earlier than in the rest of Europe.

Will the United States be next?

But what about the U.S., could it be the next vision of re-escalating virus cases? New daily cases and hospitalization rates have begun to creep in and although the US acceleration program has kicked off a decent start, it is delaying the launch of the UK. There is a risk that markets have become complacent against the continuing threat of the virus since vaccines appeared in the picture.

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Although it is not very likely that there will be renewed blockades in the United States, some tightening of restrictions cannot be ruled out in the winter months. In addition, as observed by previous virus waves, only an explosion of infection levels is needed for consumers to stay at home.

Part of the euro’s downward trend is down to the recently improved optimism for the U.S. economy, as the latest indicators suggest that growth has picked up at the beginning of the fourth quarter. If this optimism were to be questioned, the U.S. dollar could lose some of its luster, accelerating struggling currencies like the euro.

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Too pessimistic?

Another additional risk for the besieged single currency is the assumption that growth will be strongly affected by the current wave of measures. But with so much pessimism priced, there is a good chance that Europe’s economies will weather this storm much better than what markets expect.

It is also worth noting that large speculative investors are not too bearish about the euro. According to CFTC data, speculators have cut their euro-long positions a lot this year, but have only been completely short since November 19th.

Technical indicators on the other hand imply that the euro is oversold, at least against the US dollar. If buyers intervene, the 61.8% Fibonacci retracement of the March 2020-January 2021 uptrend will be the first critical test at $ 1.1290 followed by the 50% Fibonacci of $ 1.1492. Winning the latter would also help the euro / dollar regain its 50-day moving average, which is required to remove the selling pressure.

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However, if sentiment doesn’t soon turn around and the pair breaks below the $ 1.1160 support, the next test for the bears will be the 78.6% Fibonacci of $ 1,1002. Crashing below $ 1.10 would strengthen the euro’s low and open the door to a March 2020 revisit to $ 1.0635.

It’s all about the ECB

Overall, the euro remains exposed to surprises in the economic and viral data soon, which means it is likely to be more volatile going forward. As things stand, traders may overlook some of the high risks. Ultimately, however, its longer-term trend will be determined by how soon the ECB joins other central banks to signal that rates are just around the corner, and that is likely to be decided by whether the jump in inflation in the Eurozone ends up being transitional. as Lagarde believes.

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