Analysts’ Pick: The euro shows signs of weakening, and may look to retest a support following increased Covid-19 concerns
- Euro still trades within an uptrend channel, but gains may be limited by a likely easing cycle from the ECB in December
- Covid-19 concerns should also weigh on risk-assets in the short-term as economic activity appears to have dropped off back closer to levels last seen before July
- Vaccine optimism is likely to only be fully reflected in prices after logistical concerns fade
- Our outlook for EUR/USD more skewed towards the downside in the short-term as a result, but expect volatility from Brexit negotiations to be a key risk in the coming days
Central bankers came forward yesterday and signalled to markets that economic growth is likely to suffer following the surge in Covid-19 cases in the EU, UK and US. The euro in our view is likely to face strong headwinds in the coming weeks as a result, as investors and traders focus in on incoming weakness in economic data as well as a probable uptick in the greenback as safe havens return to demand. Additionally, expected dovishness from the European Central Bank (ECB) is likely to also impact the currency and may provide a ceiling for upside in the short-term.
Daily Covid-19 cases in the EU, UK and US continue to hover near or above the seven-day moving average
Covid-19 cases in the EU has started to show its effects on economic activity. An aggregated factor model created by Bloomberg that focuses on mobility, financial assets, consumer staples, electricity demand and to an extent retail footprint signals that economic activity in advanced economies have fallen off a cliff since late October. This is mainly due to the uptick in Covid-19 cases in the EU, UK and US spinning out of control and subsequently causing lockdown restrictions to be enforced in parts of all three regions. A closer look reveals that the driver for the drop off in the EU is due to major economics including France, Italy, Germany and Spain. While the dataset is not directly comparable cross regionally, historical comparisons show that economic activity has fallen back well below levels seen in the past quarter. More economic damage is likely to be seen this quarter which will probably result in easing from the ECB, something that is likely already priced in to the market after explicit signals from the central bank at its most recent monetary policy meeting.
Advanced economies have started to lag well behind emerging economies in terms of mobility activity
Economic activity in the EU and UK economies have dropped to levels seen previously before July
Additionally, while a vaccine is likely to help alleviate some of the pressure, we've seen in recent days from stock pricing movements that suggests financial markets have not fully priced in the impact of another lockdown across the EU, UK and the US. More likely is that investors will continue to price in the short-term impact of reduced economic activity in the while gradually building positions on cyclical assets to take advantage of the expected medium-term impact of a successful vaccine.
Vaccine news from here on out is more likely to be taken as positive, but markets should have already expected this with multiple drug makers set to conclude phase three trials in the current and next months. 12 vaccines are currently in phase three trials, including Pfizer's, with multiple experimental vaccines being already approved for emergency use in China and Russia. Focus instead should be on logistical issues. In Pfizer's case, its vaccine has to be stored in a deep freeze, i.e. minus 80 degrees Celsius, until it is ready to be injected. Moderna's offering will likely be the same as well, since both vaccines were developed based on mRNA. Additionally, manufacturing capacity as well as take-up rates should concern investors as well since it is unlikely that a single vaccine will be enough to meet worldwide demand in 2021. While vaccines have been approved for emergency use in China and Russia, deals have only been made with countries outside of the US, EU and UK. In our view, it is also unlikely to be approved in those countries in the short-term as well due to the lack of peer-reviewed studies and documentation.
The euro's upside is likely to be limited in the short-term as a result. In our view EUR/USD is more probable to suffer downward pressure resulting from expectations for policy easing from the ECB, and a weaker economic outlook as more to-date economic data will start to show the extent of real economic damage to the European economy resulting from the recent wave of infections. We may see the currency pair retest a support level at 1.1702's level and possibly break that to trade closer towards 1.1611. In the medium-to-long-term, the pandemic should start to show signs of peaking following lockdown restrictions and will more likely help to boost the euro over the dollar, similar to what we saw earlier this year after the EU went into lockdown before the US. Traders should also expect some volatility in the euro as we approach the November 19th EU leader summit, since it is expected to be a deadline for Brexit negotiations.
Bulls appears to be keeping control over the EUR/USD currency pair in the short-term but it does seem that bears will be able to push the currency back down following downward momentum from risk aversion that is driving safe haven demand. Fundamentally, dovishness from the ECB is likely to put a ceiling on upside as well, signalling that upward momentum has likely been lost. The most recent uptick in our view appears to be a technical correction by short sellers closing their position after the currency pair hit the 50-day moving average. This uptick as a result may not be sustained and could be a signal that the euro could sink more. With MACD zeroing out, we may also see a spike in the currency pair, which could result in a sharp swing with the added volatility from Brexit negotiations.
Support: 1.1702 / 1.1611 / 1.1472
Resistance: 1.1876 / 1.1949 / 1.2012
EUR/USD Chart (H4)