Understanding the euro’s recent rise

EUR/USD and EUR/GBP upside bias

Broad dollar weakness has been supporting the EURUSD rise lately. The EURUSD can be known as the ‘anti-euro’ index due to its strong EUR component of the Dollar Index. As a result, they have a strong negative correlation. When the Dollar Index falls the EURUSD rises and vice versa. However, it is not only Dollar weakness that is supporting the EURUSD pair. The Bloomberg EUR index is also up around 2.5% this month and up about 8% since February’s low.

 

What other factors are supporting the Euro?

The passing of the €750 billion European Recovery Fund has been a very positive sign on European solidarity to weather a storm. The so-called ‘frugal four’ did not object enough to block the fund’s passing in the end. This means that the chances of the eurozone now breaking up are seen as being reduced as the nations pull together to support the economy. This has boosted sentiment for the eurozone as a whole and supports the Euro.

Secondly, yesterday German IFO data rose across all three subcomponents giving the euro more reasons to rally. This only adds to the strong July PMI readings from last week and is at least some indication of a potential ‘V’ shaped recovery.

One risk area for the EURUSD this week is due to the US federal CARES Act. This Act has provided huge support to the households impacted by joblessness by extending unemployment insurance benefits by 13 weeks. Furthermore, it has a large payment of an extra US$600 per week to all 31.8 million unemployed. However, the scheme ends in July. So, the issue is that there is a need for more stimulus before month-end, which may prove easier said than done to finalise. This is called a ‘fiscal cliff edge’. At the end of the month, the fiscal supports dramatically ends.

 

Options markets

In the options markets that is a strong call option skew on EURUSD options, so more EUR strength is anticipated by the market going forward. The majority of these options are ‘call’ (buy side) options which means the options market is positioning for more EURUS strength ahead.

 

EUR/GBP upside bias

The UK, on the other hand, is still struggling with Brexit negotiations. The EU had out in a date for a summit of EU leaders on October 15 to approve any agreement, with the possibility to move it later in the month if needed. However, they warned that further delays would jeopardise the ratification process ahead of a vote in the European Parliament in December.

As a result, expect EURGBP buyers medium term as long as this situation remains the same.

 

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