What future for the Euro?
Currency volatility is often a harbinger of major credit events. It may be the case for the Eurozone as the EURUSD broke down the uptrend established since the launch of the currency
Currency volatility is often a harbinger of major credit events. It may be the case for the Eurozone as the EURUSD broke down the uptrend established since the launch of the currency (see monthly chart). The EZ stagflationary scenario so often anticipated on these posts (here: https://lnkd.in/gvnTuPn4 and here: https://lnkd.in/gkBJYmTK) is now confirmed with inflation at 7.5% and Q1 gdp at 0.2%. It was an easy call as the pre-C19 zombification of the EZ, the 2021/22 fiscal cliff and supply disruption, all pointed to higher inflation and stagnant growth.
Fighting stagflation would require raising interest rates. A cure the EZ can hardly afford as the gargantuan debt levels of some member states’ require structural ultra-low rates and the ECB as the sole possible buyer. As inflation becomes the key issue the status quo becomes untenable. Hence the moment of truth for the EZ is getting closer: it is either going to be a fiscal union with significant transfer of resources among members or the restructuring of the common currency area. History, data and political game theory suggest the latter. In the face of worsening economic conditions, Brussel’s slow and dysfunctional process will not do and some member states, likely the strongest, may decide to decouple and revert to monetary sovereignty or, perhaps, to a smaller currency union with fiscally like-minded countries.
The lethal combination of C19 and the Ukraine war have exposed the design flaws for the monetary union and the sanctions to Russia killed any chance the Euro may have had to be adopted as a reserve currency. As the economy deteriorates, the only relief mechanism is the weakening of the common currency, albeit ever more inflationary. Unless of a very unlikely and swift turn around for USD rates, a doom-loop for the EURUSD is shaping up. Further decline is in the cards with possible new ATL below the 0.85 level; that would imply an additional 21% decline from the current levels. Cognizant investors may want to review their EUR exposure. Disclosure: Hold all assets mentioned. Not investment advice. Do your own research.