Still Climbing

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The macro point

The message delivered last week by the European Central Bank (ECB) is enough to cause cold sweats. The economy is doing poorly (especially Germany), and inflation, even if it is decreasing, will remain high in 2024. This is the dreaded scenario of stagflation taking shape. The foreign exchange market understood well that this is bad news by immediately selling the euro. In the current circumstances, there doesn't seem to be anything that could reverse the trajectory of the single currency. To everyone's surprise (or almost), the European Central Bank (ECB) increased its key interest rate by 25 basis points at its meeting last Thursday. This is the tenth consecutive increase. The cost of money in the eurozone is now at a high point since 1999. The central bank took the opportunity to update its macroeconomic projections. To say the least, the economic outlook for the Union is not encouraging. Growth in the second quarter was revised downward to 0.1% after stagnation in the first quarter. International trade and domestic consumption are the two current weak economic points. Only business investment seems to hold. But this will surely be short-lived given the inexorable rise in the cost of capital. The growth forecast for 2024 has also been revised downward while inflation is expected to rise to 3.2%. You may have already understood, it is the scenario of stagflation that is emerging for the eurozone (low growth with potentially countries in recession, such as Germany, with an inflation level that is above normal). It is the worst scenario for a central bank and economic actors. Stagflation, if it persists, is synonymous with impoverishment. There is no good monetary solution to fight it. If stagflation becomes clearer, it is likely that the central bank will have its hands tied, which will result in a long pause in monetary policy. The foreign exchange market reacted coolly to the rate hike and the update of economic projections. The euro, which has already been in a downward trend for several weeks, collapsed against the dollar to levels not seen in six months (below the area around 1.06). It seems increasingly evident that the coming months will be very complicated on a macroeconomic level in the eurozone. The immediate decline of the euro also constitutes an important market signal, in our view. This means that traders consider the ECB has gone too far in the tightening cycle of the cost of money and that this latest increase is probably not necessary. If we base ourselves solely on the economic dynamics and the divergence at work between the United States (where the economy is resilient) and the eurozone, we can estimate that the EUR/USD pair should certainly be closer to parity. Some are even more pessimistic than us. The Institute of International Finance (which is very respected) considers that the fair price for the pair is around 0.90 (yes, you read that correctly!). However, this does not mean that the euro could fall below parity in the short or medium term. It is unlikely from our point of view. On the other hand, it seems certain that the depreciation of the currency will not stop anytime soon. Moreover, we see that the decline of the euro is not only against the U.S. dollar (which logically serves as a safe haven). It is also noticeable against nearly all other major currencies. We are probably facing a crisis of confidence from foreign investors towards the Monetary Union, which is likely to intensify in the coming months. Indeed, we do not see how the eurozone could recover while a potential fiscal stimulus is at a standstill (the ECB has even recommended that European states end support measures to fight the energy crisis) and that Germany, the main economy of the eurozone, is facing cyclical and structural challenges that will take several years to overcome. At Mondial Change, we expect stagnant or even contracting growth in the second half of the year and a very sluggish economic restart from the first quarter of 2024 (without necessarily implying a decrease in rates by the ECB because, due to the persistence of high inflation, this is not the most optimal solution).

Technical point

The EUR/USD pair could fall in the short term towards the support zone located at 1.0515. A large part of the bad news is already priced into the market, so we doubt the pair can go much lower immediately. In the longer term, forecasters are pessimistic about the EUR/USD. Danske Bank (based in Denmark) has a target of 1.03 in six months, for example. Although caution is required regarding long-term forecasts, they have the merit of showing the general mindset of market players. The supports and resistances shown below indicate respectively the low and high points within which prices should evolve during the week.

Announcements to follow

It is the turn of a new central bank to be in the spotlight this week. The US Federal Reserve is due to meet. We expect it to keep its key rate unchanged in September, notably due to the favorable dynamics observed at the level of the disinflation process, before raising rates again in November by 25 basis points. This last rate hike is not guaranteed, however. It will depend on the evolution of statistics related to the beginning of the fourth quarter. Below you will find the publications and events that should have a major impact on the evolution of exchange rates.

Day	Time	Country	Indicator	What to expect?
09/20/2023	20:00	USA	Central bank meeting	Monetary policy pause expected
09/21/2023	14:15	CH	Central bank meeting	Director rate increase of 25 basis points
09/21/2023	13:00	UK	Central bank meeting	Director rate increase of 25 basis points