The Recovery Fizzled Out

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The macro point

We would have liked to share only good news with you during this holiday season. But that will not be the case. The economic situation is deteriorating rapidly on all fronts. The economic slowdown in the Chinese real estate sector is faster than expected. In the short term, this means that China's growth will slow down significantly. In the medium term, the stimulus measures to be taken in the coming months by the Chinese government should support the European economy (particularly the German economy which is highly dependent on China). However, patience will be needed. This should only materialize in economic figures at the beginning of next year, at best. In the United States, the peak of inflation has likely not yet been reached. The first estimate of the consumer price index in June (which serves as a barometer for the foreign exchange market) was a cold shower. Inflation rose to 9.1% year-on-year last month. It is at its highest since 1981. The risk of returning to inflation levels close to those of the 1970s (above 10%) is no longer a fantasy. But as we have highlighted in recent weeks, the American economy remains strong. Household consumption is high (which is paradoxical considering the decline in purchasing power). Companies continue to invest and above all have sufficient cash levels to face the headwinds coming. Companies have filed for bankruptcy protection (Chapter 11) in recent weeks. These are generally companies that have been heavily indebted for years or companies operating in highly speculative sectors (such as cryptocurrencies). Overall, it is unlikely that we will witness a series of bankruptcies across the Atlantic in the coming months. However, at Mondial Change, we are more worried about Europe (especially the eurozone). The economy is on the edge of a precipice. The surge in energy prices (particularly natural gas and electricity) reinforces the hypothesis of a recession in the Monetary Union this year. Many governments fear that electricity shortages could occur this winter if weather conditions are very poor. Shortages are unlikely to be as severe as those experienced in some failing countries (such as Venezuela). But it will be a shock for the population and a serious blow to the most energy-intensive industries if this happens (we are thinking of the German industry, of course). Added to this is the return of political risk (much earlier than expected). Last week, Italian Prime Minister Mario Draghi lost the support of the Five Star Movement (which is one of the main actors of the government coalition). A period of uncertainties is opening. This comes at the worst time. Italian interest rates have been rising in recent weeks, increasing the risk of financial fragmentation within the eurozone (which we discussed in detail at the end of June). Finally, there is little doubt that the European Central Bank (ECB) has been too slow to tighten its monetary policy. As we often say on trading floors, it is behind the economic cycle. It wasted too much time between recognizing that inflation is not transitory (last February) and increasing key interest rates (this week). In the space of six months, the economic panorama has profoundly changed and this is not only linked to the war in Ukraine. All these combined risks have increased investor mistrust regarding the euro (especially for non-European investors). The drop in the EUR/USD pair reflects both a general increase in the dollar (a retreat to safe havens) but also growing pessimism among traders about the economic and financial situation of the eurozone. Even trying to see the glass half full, there is no element likely to cause a sustained rebound of the single currency. Crossing parity is certainly just a first step. The drop in EUR/USD is only just beginning, especially if the scenario of a severe energy crisis (marked by electricity rationing) becomes more evident this winter. Technical analysis corroborates our bearish scenario for EUR/USD. Based on data communicated each week by the Commodity Futures Trading Commission (based in the United States), institutional investors are predominantly short (sellers) on the euro and long (buyers) on the US dollar. Parity is in no way an important technical zone. It's merely a psychological level for the market. This means the downside potential is certainly greater. We are betting on a short-term drop of the pair around 0.98. The ECB will certainly try to stop the euro's depreciation this week. But we doubt it will be effective. The supports and resistances displayed below indicate respectively the lows and highs within which the rates should evolve during the week.

	SUPPORTS	WEEKLY	RESISTANCES	WEEKLY
	S2	S1	R1	R2
EUR/USD	0.982	0.9900	1.0340	1.0620
EUR/GBP	0.8230	0.8363	0.8553	0.8648
EUR/CHF	0.9525	0.9727	1.0005	1.0140
EUR/CAD	1.2730	1.2880	1.3320	1.3540
EUR/JPY	133.30	135.90	140.28	141.30

From the economic calendar's point of view, this Thursday's ECB meeting is the main event to follow if you are exposed to the euro/dollar exchange rate. Unless there is a last-minute surprise, the central bank should increase its key interest rates by 25 basis points (it's too little and too late in our view). Moreover, it should present the main lines of its anti-fragmentation tool aimed at containing the surge of interest rates of southern eurozone countries (which will certainly be useful for Italy considering both the level of public debt and political turbulence). It is likely that the ECB President, Christine Lagarde, will be alarmed by the weakness of the euro (which notably has the negative consequence of increasing imported inflation). But she does not have sufficiently effective tools to curb this phenomenon. Her (verbal) intervention will certainly be like a shot in the dark. Below you will find the publications and events that are expected to have a major impact on the evolution of currency rates.

DAY	TIME	INDICATOR	WHAT TO EXPECT?
19/07	11:00	Consumer Price Index (June)	First estimate for the month of June at 8.6% year-on-year. This would be a new increase.
20/07	08:00	Consumer Price Index (June)	First estimate at 9.1% year-on-year.
21/07	14:15	European Central Bank Meeting	Unless there's a last-minute surprise, the central bank should opt for a step-by-step strategy – only a 25 basis points increase in the key rate.
	14:30	Philadelphia Fed Manufacturing Index (July)	The consensus among analysts predicts a rebound to 5.5 against -3.3 in June.