When it comes to currencies, the euro would feel most heat – especially in Europe as a sign of recession approaching faster than in the US, the local stock markets are trading at considerably lesser multiples of forward-looking earnings, and the bond spreads between Germany and countries such as Italy are widening.
With European energy prices soaring, it may take more of a concession on the currency to entice investors into European asset markets and keep the balance of payments balanced. A sub-parity EUR/USD may be in store.
Inflation has topped 8%, and instead of acting immediately, the ECB is only promising to move in six weeks time ~ and by the minimal amount of 25 bps. That has come despite a major upgrade to inflation forecasts to 6.8%. Moreover, the bank slashed its growth forecast from over 7% to below 3% and pledged to act, if needed, to buy bonds, diluting its pledge to end its bond-buying scheme. Overall, the ECB is hesitant to act. It is only indicating a minimal rate hike next time and making promises it could find hard to fulfill later. Given the recent weakness in the Consumer Price Index, some anticipated starker language, and a hint that the bank is ready to act. That did not materialize. The ECB tolerates an increase in the euro.
It is now likely we will see ECB support begin to crumble away leaving the Euro completely exposed to the full force of rampant inflation, an ECB that cannot hike, and an ever-deepening recession. European inflation like in the US is already skyrocketing and will exceed 10% in the coming months. Economic growth will contract significantly.
Economists at Barclays estimate that an embargo of all Russian energy imports could reduce euro area GDP growth by 1.3%, or as much as 5% if rationing is imposed. They estimate that since the Eurozone imports its natural gas and crude oil requirements, a 200% shock to European natural gas prices and a 40% shock to crude oil prices would result in a 4% deterioration in the Eurozones terms of trade
On the technical side, not much changed regarding the future trajectory of the pair. EUR/USD easily broke through the psychological barrier of 1.01 and continued its downtrend amid weak Economic sentiment data and a mute ECB. Peeking into the future, we are presented with a situation that has not happened in 20 years, since 2002, but back then, the economic dynamics of the market were different.
Now, in this uncharted territory, the Euro is expected to weaken further, potentially breaking the 1-to-1 parity with the Dollar and continuing its downtrend until at least when the ECB will turn hawkish and/or the trading sentiment in Europe to improve, which is a major factor for the Euro strength. Levels to watch in that scenario are located at 0.9950 (static level from November 2002) and 0.9900 (psychological level).
On the contrary, the only credible good news for the EUR/USD bears may be that the technical indicator RSI finds the pair to be in an extreme oversold condition, a bullish signal indicating a potential technical correction to the upside. The first, important level to consider is the psychological barrier of 1.01, which is also the 20-period SMA too.
Nevertheless, the EUR/USD pair finds itself in a unique situation, and only the future policies of the ECB and the hopefully soon resolution of the war in Ukraine will remove the gloom above the once strong Euro.
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