Euro Outlook – Is 1.15 Next?

Investors continued to sell euros on Wednesday, driving the currency to its weakest level since July. Europe’s greatest fear is materializing with the number of coronavirus cases exceeding 5 million. As we indicated at the start of the week, stricter restrictions are on their way. France in particular introduced a color-coded map of hot spots and restrictions on gathering along with reducing opening hours for bars and cafes in an attempt to slow the virus spread. No one is willing to return to the hard lockdowns that were in place in the spring but even smaller measures like these will curtail growth. We’re already beginning to see a slowdown in the recovery with service sector activity slowing across the region. Manufacturing activity is up but the improvement was not enough to nudge the composite index for Germany, France, and the Eurozone higher. The Eurozone composite PMI index dropped to 50.1 from 51.9 which means the region’s economy basically stagnated in September. There’s no doubt that this second wave will cause the recovery to slow further. According to ECB member Mersch, the recovery path might be a bit closer to mild scenario. At the beginning of the week when EUR/USD was trading on the 1.18 handle we said it could fall as low as 1.15. Today’s decline marks the fourth straight day of losses for the currency pair and on a technical basis, there’s minor support between 1.1625 and 1.1650. Beyond that, it's all clear down to 1.15. Germany’s IFO report is scheduled for release tomorrow and the decline in PMIs signal potential deterioration in business sentiment.

While Europe’s troubles played a key role in the currency’s weakness, the primary story continues to be demand for US dollars. Stocks turned lower after starting the day in positive territory and this reversal drove investors into the greenback. The dollar traded higher against all of the major currencies except for sterling. Markit PMIs were mixed with manufacturing activity accelerating but service sector activity slowing which led to a decline in the composite index. The dollar took its cue from Fed speak. Fed Chairman Powell spoke again today along with Presidents Clarida, Mester, Evans, Rosengren. Powell’s opening remarks were identical to yesterday’s but today he added that they’ve basically done all of the things they can think of. Clarida expects the Fed to keep rates low for longer at least until inflation hits 2% and policy should aim for a moderate overshoot. Mester said 2.5% inflation is on the cards which means they could keep rates unchanged until prices are much higher. Rosengren fears a second wave and says he’s less optimistic than other Fed forecasters as he believes “we’d be lucky” to get 2% inflation in the next 3 years. The doves were out in droves today but the dollar was unfazed as the greenback tracks the rise in Treasury yields.

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