Hello. The world is gradually plunging into the chaos of negative interest rates and sliding into a swamp of economic stagnation. Unemployment in the United States has reached 36 million. Central banks and governments are feverishly seeking a way out of this situation. The economy hit the bottom, but continues to slide into the abyss of depression, and only stock markets, bouncing cheerfully from the lows, returned to last summer’s figures.
There has been a relative lull in the foreign exchange market, following the jump in volatility back in March, which can explode in a storm and parity between the euro and the dollar, which analysts and traders have been talking about for many years, may come true much earlier than we expect, for example, this fall. This is of course just a hypothesis, but I have grounds for this assumption, with which I will introduce the readers of this article.
To begin, let’s recall the fundamental tenets of the forex market, which, despite all the efforts of central banks to turn the world upside down, continue to work.
All things being equal, investors prefer the US dollar;
Any investment is compared to an investment in government treasury bonds;
Since you and I live in the era of the US dollar, which is the globally recognized equivalent of value, there must be good reason for investors or ordinary citizens to keep money in other currencies. A resident of Europe is unlikely to want to have a dollar in his pocket, because he simply does not need it. Goods in European stores are not sold for dollars; services within the EU are not sold for dollars. However, considering investment opportunities, a resident of the European Union will immediately see that investing in dollars will bring him more income than investing in euros. So, at least, it was before the start of the Covid-19 epidemic. And now, investments in Europe are associated with significant difficulties.
An international investor acts from a different position, on the contrary, he needs the greenback, because he can get everything that his heart desires using the dollar, while he can buy only a limited amount of assets with the euro. In other currencies, the situation is even worse, assets denominated in RMB, pounds, or rupees are catastrophically small, and most importantly, investing in these assets, the investor acquires additional currency risk. So why should an investor buy the euro, where for several years now, government bond yields have been negative, the situation with the coronavirus epidemic is not much better than in the United States, and there are very few stock assets showing stable growth.
The depreciation of the euro that we observed in 2018-2020 was a reflection of the difference in interest rates between the euro and the dollar. It would seem that now, when the rates in these currencies are practically equal, the markets should go into the trading range, but you need to clearly understand that a priori – the euro is the dominant currency, and the dollar is the dominant currency, and while the situation in the eurozone will be the way it is now or worse, the euro will be under pressure.
For the sake of objectivity, it should be noted that foreign investors are now actively leaving the US market. This is clearly seen in Open Interest (OI) in the euro futures contract traded on the CME. According to the Commitment of Traders report (COT), OI in the futures of the euro decreased from 754 to 605,000 contracts since March 13, and the total position of institutional investors decreased by a third, from 305 to 226,000 contracts. However, this rather means a loss of interest of European investors in investments in dollars, rather than an increase in the desire to invest in euros.
So how are things in Europe? The prospects for the eurozone are now significantly worse than those of the United States. According to the IMF forecast, according to the results of the COVID-19 epidemic, the European economy will fall by 7.5%, while the US economy will fall by about 5%. Thus, in the current situation, the euro is doomed to stay in a downward trend simply because Europe cannot offer investors anything attractive right now.
Of course, you need to understand that the central banks strictly monitor exchange rates, and Donald Trump will not fail to reproach the European Union for manipulating exchange rates, and promises to introduce duties against it. However, in the fall, Trump will not be in the EU, he would win the election and stay for a second term, so the euro has a window of opportunity for reduction. Moreover, in conditions of falling demand, dumping, including currency dumping, is a good way to conquer markets. However, Saudi Arabia did not succeed.
From a technical point of view, the EURUSD currency pair has been in a declining trend since 2018, and in March – April 2020 formed a graphic “pennant” figure, which, according to the postulates of technical analysis, should be broken down by the size of a flagpole, which is about 800 points. If this happens, the course will drop to the level of parity – 1 to 1.
By the way, a similar situation was four years ago, when the US president just took office. Then, the EURUSD rate was also on the verge of parity, but through agreements and direct manipulations, the Federal Reserve and the European Central Bank managed to raise the euro to the level of 1.27 against the dollar.
In general, it can be assumed that none of the parties is interested in depreciating, but now the conditions in the markets are somewhat different than they were in 2016-2017. It is possible that the US’s European allies will decide to take advantage of Trump’s election campaign or simply don’t agree with the Fed in the face of a falling European economy, which could result in the European currency’s collapse. Not the fact that this will happen, no one knows the future, including myself, but we need to take such a scenario into account.
Risk of EU collapse, according to Black Rock Corp. Institute of Analysis
The European Union is now very weak. Here is what the analysts of the Black Rock investment corporation write about this: – “After the initial disagreements in Europe, a united front emerged, characterized by a common approach to border control and export restrictions, as well as widespread unconditional support from the ECB to help finance costs, related to the pandemic. Efforts are currently underway to develop a comprehensive, significant and overall recovery strategy after isolation. Significant progress has already been made, but the shock is COVID-19, and the economic consequences will test the cohesion of the EU as never before. At the present time, we believe it unlikely surge of populism, but its renewal is likely once the acute phase of the outbreak will take place and will clear the scale of the economic damage.”
As we can see from the chart, a surge of negativity associated with the inability of the European Commission to respond quickly to the emerging crisis and tension between the Italian government and Brussels, trade contradictions and the uncertainty associated with Brexit create additional problems for Europe. Although in its history the European Union has experienced many crises, the economic consequences that have arisen after the pandemic, if they do not lead to the collapse of the EU, can significantly weaken the euro in the confrontation with the dollar. However, there is no doubt that the Euro-Atlantic elites will make every effort to prevent the collapse of the monetary union of the euro and the dollar. Be careful and cautious, follow the rules of money management. May the coronavirus pass us by!
*The market analysis posted here is meant to increase your awareness, but not to give instructions to make a trade.