Can the Euro Hold its Recent Gains?
The euro has staged an impressive rally over the past month, bouncing back sharply from the four-year low against the dollar that it reached in June.
Not long ago, as Europe was mired in a string of sovereign debt crises, there was serious talk of the EUR/USD forex pair reaching parity – a level that would have attested to genuine turmoil for the euro.
With some analysts now suggesting that the worst of the eurozone debt crisis is over, could we see the euro begin to make a more sustained recovery? Or is this a false dawn for the single currency and should we instead be expecting further weakness?
Euro strength or dollar weakness?
The way forex trading is structured means that a currency appreciates or weakens only in relative terms (i.e. against another currency). In our discussion of the euro’s recent rally, we must therefore first take into account the pressures on the euro’s primary forex rival – the US dollar.
During the past month investors have appeared far more sanguine regarding Europe, while the US and China have come under greater scrutiny from bearish analysts. There have been several consecutive pieces of weak data from the US, including a downgrade of the Federal Reserve’s growth forecast and even speculation over the need for further quantitative easing measures in the US. The net effect of increasingly pessimistic speculation and poor data has been to weaken the dollar, allowing the euro to make significant headway – even breaching the $1.30 mark last week.
At the same time, we have seen positive signs in Europe. Strategists have speculated that bond yields in the four most troubled economies – Greece, Portual, Spain and Ireland – may have peaked and investors are once again buying debt from these nations. With the European Central Bank’s continued loan offers helping to underpin confidence, there are certainly now more arguments in favour of the euro than there were a month or two ago.
Pressure on the euro
However, there remains a significant degree of antipathy towards the euro. It is thought that by as late as May 7 speculators had built an unprecedented $18 billion in short positions against the single currency, and while a large chunk of this position has since been unwound as traders have taken profits and reinvested them elsewhere, there are still major bets in place against the euro.
Sovereign debt is still the key factor keeping the euro under pressure. If the first phase of the debt crisis was alleviated by the promise of central-bank cash, investors now see the second wave of as an inevitable consequence of the austerity measures that have already begun to sweep the eurozone and one of its key trading partners – the UK.
With well over half of UK exports heading to the eurozone, and an equally significant number of goods moving in the opposite direction, the austerity plans on both sides of the English Channel may impact on the euro and sterling alike, leading to both currencies weakening against the dollar.
Is the dollar still a safe haven currency?
This is a key question for forex traders, but the jury is still considering their verdict. The dollar certainly appears to have lost some of its sheen as far as its safe haven status is concerned; the yen and (to a lesser extent) the Swiss franc are the new havens according to some forex analysts. As such, one cannot rule out the possibility that the recent strength of the euro against the dollar was due in part to the US currency no longer automatically benefiting during periods of risk aversion.
On the other hand, there are still signals suggesting the opposite is true. As risk aversion towards equities kicked in on July 20, with fears over poor corporate results in the US hurting indices on both sides of the Atlantic, the dollar actually rose on the forex markets. With credit agency Moody’s recent downgrade of Irish debt, the dollar may once again start to look an attractive option as scepticism over the eurozone flares up again.
The issue appears to be a matter of degrees, rather than a question with a definitive answer. Nevertheless, if forex traders do begin to hesitate before ploughing cash into the dollar when risk aversion is peaking, the euro may well benefit.
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Updated: 20/07/10
The above comments do not constitute investment advice and IG Index accepts no responsibility for any use that may be made of them.
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