Euro Strength may be an Achillies heel for exports

5 giu 2020

The Euro sees its longest streak in 15 years on the back of Christine Lagarde, announcing that the ECB will provide an extra 1T in stimulus to combat the effects of the Coronavirus. The Euro against the USD has spiked to 1.127 to just under 1.135 on the back of extra stimulus. Pointing to inflation and price stability as concerns, Christine Lagarde stated a “unanimous view that action had to be taken.” However, with over six years of Quantitative easing and negative rates, the Euro’s weakness has benefited its exporters. This may change as the ECB puts its foot down in trying to rescue Europe.

History of the Euro post Financial Crisis
The European Union was hit hard during the Financial Crisis, with the Annual GDP growth rate dropping to as low as -6%. Europe did experience some GDP growth in the early 2010s, however, quickly reverted back due to the strong Eurodollar. Mario Draghi, ECB’s president at the time, implemented a drastic Quantitative easing program alongside negative interest rates. This gave the European union the boost it needed, with GDP Growth staying positive alongside the Balance of Trade, also staying positive in the following six years.

However, there has been a different tone from Lagarde, even before the Coronavirus pandemic.
With negative interest rates, investors in the European Union struggled to find yield while the American financial markets were experiencing capital appreciation alongside positive yield. Draghi consistently held that “for rates to be higher in the future, they need to be negative now.” However, with a change of leadership in the ECB at the turn of the decade, Lagarde is seen to take a tepid tone when it comes to negative rates. This was explicitly exemplified during the peak of the Coronavirus. When central banks all around the world were slashing their rates, Lagarde stood firm and kept rates as is. Lagarde is looking at the long-term future of the European Union and is possibly using the current pandemic to spur a change. However, with Lagarde’s new focus on getting out of this real negative rate environment, this may bode detrimental to exporters in Europe. A stronger Euro means it will cost more for buyers of European exports to purchase the Euro, possibly turning around their positive balance of trade.

What is the future of the Euro?
The Euro Dollar is currently at a key resistance around the 1.15 level, which has not been consistently able to break since quantitative easing and negative rates were implemented in 2014. We need to see if bulls will break this resistance, solidifying markets consensus for a strengthening in the Euro. If it sees a rebound at around this level, we may see a deep contraction to the downside.