Foreign-Exchange Focus Turns to Europe's Economic Fundamentals
The euro is poised to strengthen after the victory of the centrist Emmanuel Macron over Marie Le Pen in the French presidential election on Sunday. The euro-parity trade has missed its mark -- and the lows of December 2016 have set up a trading trajectory for the single currency that has consistently presented a trend of higher lows and higher highs. This is likely to continue with Macron's win.
Markets are now likely to move on from the notion that one of the founding members would walk away from the European Union. While Brexit was a headline grabber, the EU project was never about the U.K. France electing a leader favoring leaving the EU would have been a much bigger deal. In addition, France is in the euro zone, and a departure could have been far more chaotic for currency markets than Brexit.
As extreme euro political risks fade, the focus of foreign-exchange traders is likely to shift toward economic fundamentals. And the euro zone's economic situation is not just positive, it is downright strong. Manufacturing PMI has expanded over the past 46 consecutive months, with significant recent accelerations. Neither the U.S. nor China can boast of similar strength -- especially after decelerations in the April Chinese Caixin Manufacturing PMI and the April ISM Manufacturing Index.
The labor market has also improved significantly in the euro area. As in the U.S., euro-zone unemployment rates have fallen to the lowest levels in years. For the U.S., it was 4.4 percent for April, the lowest since May 2007, as the most recent gross domestic product report showed first quarter PCE at 2 percent. In the euro zone, where unemployment is structurally higher than in the U.S., the rate for March was 9.5 percent – the lowest since April 2009. Moreover, euro area consumer inflation rose in April to 1.9 percent. But while Federal Reserve expectations are hawkish -- with a half-dozen or so rate hikes expected by the end of next year -- the expectation that the European Central Bank will act in that time period is very low.
In other words, markets continue to underestimate the path of future ECB policy rates.
Even though the April U.S. employment report and potential modest increases in U.S. inflation in this week’s CPI report raise the odds of a June Fed rate hike, euro zone fundamentals are in some respects more hawkish for monetary policy, because of the ECB’s greater focus on containing inflation, keeping to a firm 2 percent target. This driver of policy -- and the corresponding euro area economic fundamentals -- are likely to support the euro on trend, even if Fed rate hike expectations were to become slightly more hawkish.
Trading technicals feed on fundamentals, and both are supportive of the euro. Even before France's election, the upside fundamental economic risks for the euro area had supported a trend of price-bullish technicals. Moves in the euro were supported following the French primary in April -- but they have also been driven by the rising level of euro-area inflation. This has created technical momentum, with the euro trading above the critical 30-day and 100-day moving average, as well as in a pattern of higher lows and higher highs since December 2016. Plus, other momentum, relative strength, and volume technicals like the Stochastic, Relative Strength Index, and On Balance Volume have provided bullish confirmations in trading over the past month. Technicals currently convey support for a bullish euro -- and if euro area fundamentals remain solid, that case is likely to strengthen. Technicals could feed on further fundamentally driven increases in the value of euro, leading to a trading pile-on and exacerbating the risks of a significant upside breakout for the currency -- even from current levels.
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