Currencies were generally stronger last week at the dollar’s expense, with only the Japanese yen showing a little more weakness which is itself a sign of improving risk sentiment. The combination of relaxing lockdowns and some improvement in the high frequency survey data in May are providing some grounds for hope that the worst might be over as we head into June, which is causing the US dollar to lose ground.
However, the disconnect between markets and the main economic data remains stark, and investors are also overlooking the brewing US-China tensions. Whether they can also ignore the ugly protests in America this weekend also remains to be seen, although how this will play out in currency markets is unclear, as it may well reinforce the negative dollar bias already under way.
This week will also bring more bad data from the US, Europe, and Asia, culminating in the US May jobs report on Friday, while the European Central Bank meeting will also be in the spotlight following on from the fiscal stimulus programme announced by the European Union Commission last week.
Most noteworthy last week was the rally in the euro, which is now at its highest levels since lockdowns began in March, above 1.11 against the US dollar, up from levels below 1.07 seen at the height of the coronavirus crisis.
Certainly the relaxation of lockdown measures in Europe on the back of reducing numbers of coronavirus cases are helping euro sentiment, but it seems the steps announced by EU Commission president Ursula Van Leyen last week were the most influential factor in powering the euro higher.
The European Commission’s fiscal stimulus package was certainly much bigger than originally expected at €750 billion (Dh3.06 trillion / US$832.5bn) – 5.4 per cent of EU gross domestic product – up from the €500bn proposed on May 18 by France and Germany. Beyond the first €500bn, which will be given as grants, the additional €250bn will likely be in the form of loans, potentially with some conditions attached.
The real significance of the stimulus plan, however, was perhaps not in its size but in the EU’s preparedness to borrow on such scale for spending across the eurozone. The stimulus package would be funded by joint debt issuance, something which Germany, and other members, had resisted until a couple of weeks ago.
Distributing funds directly from the EU budget with few or no conditions has become a political hot potato in meetings of EU leaders but this latest plan moves the economic bloc further towards some form of fiscal union. This would go a long way to boosting the integrity and resilience of monetary union, and hence explains the euro’s positive response.
There are still significant hurdles to be overcome though. The proposal will need to be approved by all 27 member states, which may still prove difficult with the so-called ‘frugal four’ of Sweden, Austria, Denmark and the Netherlands still opposing debt mutualisation.
Sweden already said it won’t support the plan in its current form. Austria, the Netherlands and Denmark are also opposed to grants, so it may take time to resolve these differences. Funding is therefore unlikely to be received by recipient countries, mainly Italy and Spain, until early next year, and in the first instance it will be relatively modest.
In principle, the movement seen from the EU last week has been in the right direction, more than making up for the concerns a few weeks ago about challenges to the Bundesbank and the ECB from the German Constitutional Court over quantitative easing. This issue will likely come back to the fore in a few weeks’ time when the Bundesbank has to respond to the court’s ruling, which could cause the euro to lose ground again. But it is doubtful if this will seriously compromise the ECB’s QE programme for long.
Looking ahead, if the EU shows it has used this crisis to overcome challenges to its system and reform its policy architecture, then it will have gone a long way to resolving some of the single currency’s key design flaws and vulnerabilities.
Tim Fox is the chief economist and head of research at Emirates NBD