Euro benefits from risk aversion

Euro Research Report

Euro benefits from risk aversion

MPC vote 8-1 to leave rates on hold

Sterling Euro (GBPEUR) FX Technical Analysis

It was a wild ride in the financial markets this month and the volatility that we experienced on Black Monday echoed the crash of 2008. Fears of a deepening economic slowdown continued to haunt investors, resulting in a sharp deterioration in market sentiment. It is hard to fathom that just a few weeks ago, the Greek debt crisis put the future of the euro in jeopardy and with the recent resignation of Prime Minister Alexis Tsipras had the potential to worry investors. In the wake of the crash however the Euro was the prime benefactor and has become a go-to currency for investors in times of stress. This triggered an aggressive correction to break the long term up channel from the recent 8 year high’s to drop 10 cents to the mid 1.30’s.

The ECB’s quantitative-easing program has driven down borrowing costs in the Eurozone, turning the euro into a funding currency for a carry trades. The recent rise of the euro reflects capital flowing out of emerging markets as traders continue reversing their short positions. The thing to note is this is a function of currency trading rather than an expression of growing confidence in the Eurozone. This is evident in inverse correlation between the Euro and the stock market, i.e when the stock market goes down the Euro goes higher.

After the fastest expansion in four years during the first quarter, GDP eased the second quarter, which was reflected in a weaker Germany reading too. Germany however is still doing better than other major European economies, notably France whose economy stagnated between April and June.

The last thing the euro area needs right now is a stronger currency. As slower global growth is almost certain and as the region continuing to flirt with deflation. European investors are worried that a cheaper Chinese currency will make European exports less competitive which ultimately may lead ECB President Draghi to make dovish comments to weaken the currency or a more drastic measure, may force the ECB to extend QE past Sep 2016.

On a day dubbed “Super Thursday”, the Bank broke with tradition to publish the MPC’s August rates decision, the minutes of the meeting, and its quarterly inflation report, alongside Bank governor Mark Carney’s regular press conference. Only one Member Ian McCafferty voted for an immediate rise in the BOE’s benchmark however it was the tone which had changed from some of the other members that kept the GBP buoyant.

A surprisingly stronger-than-expected UK core inflation reading and a thriving UK Service Sector set the UK on a solid footing to raise interest rates in the first half of next year. This positive news was quickly forgotten as economists shed doubt on prospect of this positive inflation trend being maintained in the longer term as weak Retail Sales data proved to be unsupportive and the recent concerns of the global slowdown - diminishing the chance of rate hike in near term. Subsequently the Pound dropped to its biggest one-day loss against the single currency in six years.

For EUR Buyers

The exchange rate has broken up the channel, presenting you with a long awaited opportunity. The exchange rate has dropped close to 10 cents from the highs around 1.44 and this is undoubtedly a technical move rather than a fundamental shift. There is still clear support which coincides with a 50 % retracement from December low to the July high, so now is an excellent time to reduce your exposure.

For EUR Sellers

After observing the exchange fall from the highs, now is not the time to panic however protecting yourself with a stop loss is vital especially with the volatility we have experienced recently. Having found strong support at the 50 % retracement, we would expect this level to hold and use this as a base to reverse much of the losses.