After a period of persistent underperformance, veteran trader David Jones thinks the euro’s fortunes might finally be changing.
As February got underway, the UK started its first few days of being outside the EU. But there was also something significant happening for Europe’s common currency – it slipped to its lowest level in more than two and a half years. Are financial markets being too pessimistic about the euro’s fortunes – and could it actually be the surprise ‘winner’ in 2020?
The euro has not had the best of times in recent years. Typically, when talking about the euro in broader terms, it is the euro US-dollar exchange rate (EUR/USD) that is used in financial markets. After a strong performance in 2017, the years since have seen a steady decline in EUR/USD.
EUR/USD September 2016 to present
Even against the pound − which has of course had its own challenges in recent years – the euro to pound exchange rate (EUR/GBP) is back to its lowest values since immediately after the June 2016 referendum vote.
EUR/GBP April 2016 to present
What’s gone wrong for the euro?
If you take a look at some of the recent economic numbers for the eurozone it can be seen that not much is going right at the moment – and a weaker economy normally has an immediate impact on that area’s currency.
In the final quarter of 2019, the eurozone economy just about achieved growth – but at a mere 0.1%. The figure was not that much different for the UK, but it is the ongoing sluggishness of that traditional powerhouse, the German economy, that is weighing on sentiment. In 2020 as a whole, the German economy grew by 0.6%. This was its lowest rate of growth since 2013 and last year Germany narrowly avoided slipping into an official recession by the smallest of margins. Now this hardly means that the German economy is on its knees – it still has one of the lowest percentage unemployment rates in the world – but if industry is weak in Germany, it seldom bodes well for the rest of the EU.
Is the European economy past the worst?
There was plenty weighing on the European economy last year. Of course, we are all well aware of the impact that the lack of progress on Brexit had in the UK – but the threat of a potential “hard Brexit” was doing the EU no favours either. There was a virtual sigh of relief in foreign-exchange markets following the December general election, where it looked like finally things would move forward. A sharp rally in the pound against the US dollar saw a similar move by EUR/USD. But for the euro, all those gains and more have been given up in 2020 on the back of the latest weak economic data.
In addition to Brexit, the trade wars and threats of increased tariffs from the US weighed heavily on economic sentiment in the second half of last year. Agreement was reached between the US and China – but this seems more of a short-term fix, so those concerns of a global slowdown have not fully receded.
And just when economists may have thought that there was finally some light at the end of the tunnel, 2020 has brought the coronavirus crisis. At the time of writing, it is still not clear just how large the economic impact will be – we are already aware of the devastating human impact this has had so far, in under two months. More uncertainty for the world economy does not bode well for sentiment towards the euro changing any time soon.
The contrarian trade – buy the euro
I think plenty of people love the idea of being a contrarian in financial markets; rushing in to buy as all the misguided ‘sheep’ are selling − and then being rewarded with an immediate rise in price! If this were Hollywood, this is how it would work all the time. But the reality is that those who cannot resist trying to ‘catch a falling knife’ often have plenty of time after to regret it – and the opportunity to buy in even cheaper as the slide continues. I think a good dose of common sense is needed when we are tempted to go against a major trend, so let’s take a look at the facts.
EUR/USD April 2008 to present
While there has been the occasional − and impressive – rally along the way, the euro has been losing ground against the US dollar since 2008. In that time, one euro has gone from buying almost $1.60 to now struggling to get more than $1.08. Given that major economic shifts tend to happen with the speed of an oil tanker turning rather than the nimbleness of a speedboat, it does not look like we are set to see a V-shaped recovery in the euro any time soon. A bit of patience would not go amiss here.
But there is a very important level to watch in the coming weeks and months – and it is not a million miles away from where the market is now.
EUR/USD November 2014 to present
Over the last five years, EUR/USD has gone hurtling towards these lows on three previous occasions. And that is normally when the negative market commentary gets stepped up, with plenty forecasting the euro to hit parity with the US dollar – where one euro is worth one dollar. So far, this parity has not happened – the last time the rate was that low was 2002. As can be seen from the chart, historically EUR/USD has bottomed out in the $1.03 to $1.05 area.
Of course, history does not have to repeat this time around. But, as we edge closer to those old lows, I think we may finally see the fortunes of the euro changing, and it may offer up a potentially great entry point, if you think the euro will recover for the rest of 2020.