Investment Ideas

EUR/USD rockets on ECB’s €600bn QE package, next move?

EUR/USD has jumped over 5% in just 3 weeks, surging into the overbought region of the RSI indicator

Tom Bonney
Posted Fri 5 June 2020
by Tom Bonney

Illustrated on the price chart at the bottom, the EUR/USD has jumped 5.06% since May 14th lows to a price of $1.132 as of writing (14:40GMT). This move has largely been fuelled by a tumbling US Dollar. The US Dollar, which is considered a safe haven, has fallen with uncertainty subsiding. A risk-on mood has entered markets with some of the most depressed sectors, including banking, travel and retail stocks, witnessing a recovery. This positive sentiment has come amid the re-opening of economies. Much of Europe has now re-opened its bars, restaurants, and shops with the number of new cases easing. Moreover, all 50 states in the US have eased some lockdown restrictions. Concerns of a second peak have also faded, and markets have continued to shun weak fundamental economic data. As a result, the US Dollar has tumbled 3.9% since May 14th highs to a price of 96.68DXY (at 14:40GMT).

The rest of the move can be attributed to the Euro. Throughout the coronavirus pandemic, countries which have emerged from lockdown have typically witnessed inflows into their currency. It is likely this channel sparked the upside for the Euro, with much of Europe easing lockdown restrictions in early May.

Hopes of further fiscal stimulus has also provided upside for the EUR/USD. Typically, fiscal stimulus provides upside for a currency because it reduces the need for lower interest rates. The so-called frugal northern countries (including Germany, Netherlands, Sweden, Denmark and Austria) had previously rejected the idea of cash grants, opting instead for loans. However, southern countries such as Spain, Italy, France and Greece claimed loans would overburden their public finances. On the 15th of May, Angela Merkel said Germany would back a €500bn cash grant after speaking with Emmanuel Macron. The European Commission then announced plans to mobilise a €750bn package on May 27th, including €500bn in cash grants. If the other frugal countries approve this package, this would prove a major breakthrough for the bloc which has struggled to pass communal debt in the past.

 

Typically, Quantitative Easing (QE) also appreciates a currency because it is considered an alternative to lowering interest rates. Yesterday, the ECB agreed to further their existing bond-buying programme by €600bn. This figure brings their total QE package to €1.35tn. On the back of the news, the EUR/USD jumped 0.93% to a price of $1.1338. However, the EUR/USD pair has surged into overbought territory, according to the Relative Strength Index (RSI). The RSI is a stochastic indicator which measures the speed and size of price deviations. Illustrated on the graph below, the EUR/USD pair has jumped into the overbought 70-region for the second time in 2020. Note that the pair failed to break above this level in 2019.

Thoughts? The 5% jump in the EUR/USD since mid-May has been driven by a weakening US Dollar, re-opening European economies, hopes of fiscal stimulus, and further QE. However, the EUR/USD has entered overbought territory. As a result, markets are weary of a sell-off. In an interview with Bloomberg, a strategist at ING Bank said “the ECB-induced euro rally is running out of stream”. Georgette Boele from ABN Amro also said it is too early to expect a “continued strong rally”. Looking forward, if the US Dollar continues to sell-off amid a risk-on mood, it is likely the EUR/USD will continue to rally. However, the EUR/USD has pinned its hopes on a fiscal package worth €750bn. If this falls through, we could see downside for the EUR/USD pair. The next couple of sessions will be an interesting watch.

Sources: FX Street and Bloomberg.

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