Euro on Knife’s Edge

EU members are battling to reach a consensus over the bloc’s US$ 2.2 trillion stimulus and budget deal. Separately, negotiations over a post-Brexit trade deal between the UK and the EU are widely expected to conclude this week, though the outcome remains far from certain.

EU staring at political and financial paralysis

Let’s start with the EU’s recovery fund and spending plans for the 2021-2027 period, which is seen as key for the EU economy to help cope with the pandemic. The US$ 2.2 trillion package is facing political resistance from Hungary and Poland, with these two non-euro members threatening to veto the plans. Both countries are now being pressured into taking their foot off the veto pedal, or risk losing out on billions in aid.

If invoked, it could force the EU into a partial shutdown by 1 January. That means member nations can only operate on emergency monthly budgets, as opposed to being able to roll out the full array of government financial support in a time of deep economic pain.The stakes are indeed high for both sides of this political standoff, as it risks delaying the much-needed funds at a time when the continent could use more fiscal support sooner rather than later.

Take Europe’s largest economy for example. Although Germany’s recently-released October factory orders, industrial production data, and retail sales all exceeded market expectations, the road ahead still poses downside risks, as warned by the Bundesbank. Covidd-19 curbing measures are still in place until next month, which means that the Q4 GDP print may fall back into contraction.

Pullback necessary for EURUSD

Yet, markets appear relatively sanguine about such negative risks for the EU. At the time of writing, the Euro is gaining against most of its G10 peers on Tuesday, while EURUSD is holding around its highest levels since April 2018 and remains above the psychologically-important 1.20 level.

However, from a technical perspective, the recent pullback appears to be in order for the world’s most-traded currency pair, given that EURUSD’s 14-day relative strength index had crossed the 70 mark, which denotes ‘overbought’ levels. Perhaps the catalyst for a more pronounced pullback could be confirmation that Poland and Hungary are pressing ahead with their veto threats.

Brexit negotiators in last-ditch deal frenzy

Then there’s the well-documented drama surrounding Brexit. The UK and EU are hoping that a post-Brexit trade deal can be secured in the near-future, with UK Prime Minister Boris Johnson heading to Brussels for crisis talks.

Although both sides are still looking to reach a compromise over key sticking points, such as access to British fishing waters, adding to the complications is France’s threat to veto the deal if its details are not to their liking.

Note that the 31^st December deadline Brexit is set in stone; the UK will leave the EU starting 2021.

The question now is whether these two heavily-intertwined economies can seal a deal which cushions the ensuing economic fallout in the post-Brexit era. The UK economy is forecasted to suffer see a GDP decline of 1.5 – 2 percent in the event of a no-deal Brexit, while Bank of England officials have warned that a hard Brexit could have a more lasting impact on UK businesses and economy compared to the pandemic.

Months of uncertainty have kept EURGBP mostly within the 0.886 – 0.916 it has adhered to since May. A no-deal Brexit could well jolt this currency out of this range.

However, the threat of a no-deal Brexit has not deterred the Pound from taking advantage of the weaker US Dollar. However, the long-term 1.35 resistance level is once again proving to be the undoing on GBPUSD’s attempts to push higher.

All eyes on EU summit, ECB decision

Both the EU’s recovery package and also the post-Brexit trade deal are set to feature prominently at the two-day summit for EU leaders beginning 10 December. Ideally, agreements can be sealed on both fronts to be brought before the summit this week.

Should both major deals be secured, that could also go a long way in ensuring the efficacy of the ECB’s additional policy stimulus, which is widely expected to be rolled out at its 10 December meeting.

Otherwise, there could be chaos surrounding European assets. The Euro and the Pound could then face major bouts of volatility as investors reprice the economic outlooks for the EU and the UK.

The FXTM EUR Index, which measures the Euro’s performance against six of its equally-weighted G10 peers (USD, CHF, GBP, NZD, CAD) could also do with a picker-upper. The index appears set for a ‘death cross’ forming on the daily chart, with its 50-day simple moving average (SMA) closing in on its 200-day counterpart, and such a technical event could herald further declines for the asset.

Written on 8/12/20 07:00 GMT by Han Tan, Market Analyst at FXTM

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