EUR/USD: what do the fundamentals say?

EUR/USD: what do the fundamentals say?

EUR/USD has been trading in a broad range between 1.15 and 1.12 for the fourth consecutive month. Does the euro have a chance to strengthen versus the USD or should it, on the contrary, get to lower levels? Let’s analyze the fundamentals and find out the most likely direction.

Economy

The economy is the source of troubles for the euro. At the beginning of February, the European Commission cut the 2019 growth forecast for the 19-nation bloc from 1.9% to just 1.3%.

The recent releases look grim. This month the region’s manufacturing PMI fell into the negative territory, while economic confidence declined for the eighth month in a row. The ECB governing council member Benoît Cœuré said that the economic slowdown is “clearly stronger and broader” than the European Central Bank expected.

What is threatening the economic wellbeing of the euro area? Firstly, there are global risks you’ve certainly heard of before: Brexit and China’s economic slowdown. Secondly, the eurozone has its own internal demons: political instability in Italy, public dissatisfaction in France, and struggles of the German car industry to adjust to the regulatory changes.

Given the bleak economic picture, why is the euro holding its ground versus the USD? One of the reasons is that the common currency is supported by the strong foreign demand for the European long-term government bonds. These bonds seem attractive because they offer investors a chance to place money safely and for a prolonged period of time — which is something they can’t achieve using stocks. As a result, the euro area experiences an inflow of funds from abroad. This keeps its current account in a big surplus and boosts the euro. Improvements in the US-China trade relations are also having a mildly positive impact on the EUR.

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ECB

The monetary policy of the European Central Bank is the major driver of the euro. In December, the ECB ended net asset purchases and outlined its intention to start normalizing monetary policy this year.

The upcoming ECB meeting on March 7 will be very important. On the one hand, there are reasons to expect some bad news for the single currency. Firstly, the regulator will likely acknowledge the downgraded economic forecasts. Secondly, the ECB may also extend its current easing initiatives, for example, TLTROs (targeted long-term refinancing operations). Finally, it can delay the first interest rate hike. Earlier the central bank said that it might change rates after summer 2019 but now it may remove this kind of guidance from its statement.

On the other hand, all of the things listed above don’t mean that you should rush into selling EUR/USD. For the one thing, the ECB is clearly aware of the demand for the eurozone bonds. This can make the regulator sound less dovish than expected and thus provide the euro with some strength. Moreover, help for EUR/USD may come from the American side of things.

US dollar

Although last year America has outperformed the euro area economically, this advantage of the United States is becoming less evident. In addition, the Federal Reserve has taken a pause in its interest rate increases. According to the forecasts, the US GDP growth has slowed down growth from 3.4% in Q3 to 2.4% in Q4. If we get a confirmation of these figures on Thursday, February 28, the USD will suffer, while the EUR will be able to test resistance levels.

Conclusion

As you can see, we are dealing with the weakening European economy and the external risks on the one hand, and the declining USD and the demand for the European bonds on the other hand. These contradicting factors can easily keep EUR/USD in the 1.15/1.12 range. The ECB meeting next week represents a challenge for the euro. Be ready for a spike in volatility. Still, keep in mind that any selloff in the single currency will likely be met with demand.

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