Fundamental Forecast for the Euro: Neutral

• The euro stabilized last week as the European Central Bank signaled that it would raise its main interest rate by July.
• The economic calendar offers few meaningful data releases; speeches by ECB President Christine Lagarde will garner the most attention.
• According to the IG Client Sentiment index, the euro has a mostly mixed bias against its major counterparts.

Euro - Week in Review

The euro had a mixed week as the calendar turned through the middle of May, but evidence is emerging that the worst may be over in terms of the consistent selling that has thus far defined 2022. With the European Central Bank signaling that it will raise rates sooner than previously discussed, European bond yields have stretched higher, providing a cushion for the beleaguered euro. 

EUR/USD rates led the pack higher, gaining +1.45%. EUR/JPY rates gave up most of their gains by the end of the week, but still added +0.35%. Elsewhere, EUR/GBP rates dipped by -0.41%, and EUR/CHF rates sunk by -1.20%.

Eurozone Economic Calendar Quieter

While markets – especially commodities – continue to focus on the Russian invasion of Ukraine and its knock-on effects for the European economy, attention should shift back towards data releases in the coming days, even if there are only a handful of meaningful releases.

Here are the key events in the week ahead on the Eurozone economic calendar:

• On Monday, May 23, there is a Eurogroup meeting, while the May German Ifo business climate survey will be released at 8 GMT.
• On Tuesday, May 24, the May French manufacturing and services PMIs (flash) are due at 7:15 GMT, followed by the May German manufacturing and services PMIs (flash) at 7:30 GMT, then the May Eurozone manufacturing and services PMIs (flash) at 8 GMT. An Ecofin (Economic and Financial Affairs Council of the European Union) meeting will begin at 8 GMT. ECB President Christine Lagarde will speak at 18 GMT.
• On Wednesday, May 25, the final Q1’22 German GDP report will be released at 6 GMT. ECB President Lagarde will speak again at 8 GMT.

ECB Rate Hikes Dragged Forward

How quickly things can change. At their meeting in late-April, the European Central Bank suggested that an end to stimulus efforts in Q3’22 remains the most likely course of action, with rate hikes following soon after. But as the Russian invasion of Ukraine has pressed on, inflation has become more entrenched, demanding reconsideration by various Governing Council members.

Earlier in May, ECB President Lagarde said that she would support a 10-bps rate hike in July, followed by similar comments by ECB Governing Council member Mario Centeno last week. ECB Governing Council member Klaas Knot went a bit further, suggesting that a 50-bps rate hike should be on the table.

What this means is that the gap between the ECB and rate hike expectations has closed, with the market winning out. It now appears that the ECB will end asset purchases at their next meeting in June, paving the way for policy tightening in July. More importantly, because the ECB has buckled under inflation pressures, markets are now predicting that a more rapid pace of rate hikes will transpire over the course of 2022.

French, German, Italian, and Spanish 2-Year Yields (May 2020 to May 2022) (Chart 1)

The main impact of rising ECB rate hike odds can be seen in the short-end of various European sovereign debt yields.

There has been a rapid rise in 2-year yields among the four largest economies in the Eurozone: the Italian 2-year yield is at its highest level since December 2018; the French 2-year yield is at its highest level since April 2014; the Spanish 2-year yield is at its highest level since March 2014; and the German 2-year yield is at its highest level since October 2011.

Rising short-end bond yields should prove supportive of the euro; if not leading to more strength, they will at least help stem some of the recent weakness seen throughout Q2’22.

CFTC COT Euro Futures Positioning (May 2020 to May 2022) (Chart 2)

Finally, looking at positioning, according to the CFTC’s COT for the week ended May 20, speculators increased their net-long euro positions to 15,804 contracts from 10,572 contracts. Euro positioning is now net-long for two consecutive weeks, after briefly flipping into net-short territory earlier in the month.