Is the EUR in for More Pain? There May be Choppier Waters Ahead

Trade talks delivered strong gains across the European and U.S equity markets last week. What’s on the horizon for the DAX and EUR? · FX Empire

Bob Mason

Updated Fri, Feb 15, 2019, 6:56 PM

Last Week in the Equity Markets

It was a week of contrasts for the global equity markets and, while the ongoing U.S – China trade talks was attributed to the moves through the week, is there more to it than just the trade war chatter?

Looking at the U.S and European majors, it was quite a week. Leading the way was CAC, which rallied by 3.86% to move into positive territory for the current month. The DAX and EuroStoxx50 weren’t far behind, with gains of 3.6% and 3.37% and all 3 came in ahead of the Dow that led the way in the U.S, with a 3.09% rise.

In spite of the European majors leading the way, there’s one distinct difference and it’s in the year-to-date returns. While this week’s moves certainly helped the Dow to its 4.71% gain year-to-date, the DAX sits with a whopping 12.52% loss year-to-date. The EuroStoxx50 and CAC have fared better, with losses of 7.5% and 3% respectively, but of great concern must be the slide in the DAX.

When considering the doom and gloom that has plagued the markets, uncertainty over global trade the major contributor, even the Hang Seng has done better. While down by 0.16% for the week, the Hang Seng is down by just 6.75% year-to-date. Perhaps a true reflection of the region is the 17.17% slide in the CSI300 year-to-date, which could have been far worse had it not been for a 4.28% recovery through the current month.

Economic Indicators and Trade

Looking at the EU, economic indicators out of Germany have certainly justified the lackluster performance of the DAX. A heavily export-reliant economy, exports accounted for just shy of 50% of Germany’s GDP in 2017, troubles within the auto sector and weakening demand from China have been punishing.

The slide in exports would have almost certainly contributed to the fall in private consumption in the 4^th quarter of last year, the combination of which led to Germany’s first economic contraction since 2015.

While the good news is that the outlook is brighter for the auto industry and ultimately the German and Eurozone economy, there remain a number of possible threats that could cause further chaos and deliver another blow to a sector that seemingly has the greatest impact on the German economy.

The Risks

Brexit will likely be giving the Bundesbank and Chancellor Merkel some sleepless nights. The UK imported a reported €25bn, by value, of cars from Germany in 2017. Tariffs in the event of a no-deal departure from the EU would see the UK import of motor vehicles slide as economic troubles hit.

Risk number two and perhaps a more likely event is the likelihood of the U.S administration rolling out tariffs on EU goods imported into the U.S. The U.S is Germany’s largest export market for motor vehicles, with an estimated €26.9bn, by value, exported to the U.S in 2017.

With the economy having faced its first major test in the final quarter of last year, there may be more downside to come. Emissions scandals and new emissions testing rules may have contributed to the 4^th quarter contraction, but look out for the U.S administration and the EU…

There’s one other major importer of motor vehicles from Germany, that being China. Imports, by value, into China totaled an estimated €21bn in 2017. A collapse in trade talks between the U.S and China, a no-deal Brexit and U.S tariffs on the EU’s auto sector would be quite a blow to an already struggling economy.

And the EUR

Interestingly, when looking across to the EUR, things are not as bad as one might expect. Monetary policy divergence remains in favor of the Dollar, whichever you slice and dice it. The FED has acknowledged a need to monitor, not to bring to an end, the move towards policy normalization. In stark contrast, the only move that the ECB has been able to make is to bring an end to its asset purchasing program. Deposit rates are still negative and interest rates continue to sit at zero.

A relatively benign week saw the EUR fall by just 0.24% to leave the EUR down by 1.33% against the Dollar for the month. While the EUR is down by 5.91% year-to-date, sitting at just shy of $1.13 levels suggests more downside to come should economic indicators fail to improve.

Numbers out of the U.S were less than impressive last week, with the bears calling the economy’s peak. With China having slowed, the UK heading for an extended period of uncertainty, weaker demand from the U.S for European goods and motor vehicles, in particular, also suggest a downward bias for the EUR. A slowdown in the U.S would also give the U.S administration greater incentive to drive demand for domestic goods over foreign goods and that would surely mean tariffs on EU goods.

We’re in for an interesting time ahead and, while the U.S and China appear to be making progress on trade talks, another Trump victory would likely bring the EU into the sights of the Oval Office going into the summer.

This article was originally posted on FX Empire