The euro reveals green signs of optimism

This article is exclusively dedicated to examining the basic profile of euro. For a detailed look at the single currency’s technical outlook and price action signals, download the full Q1 forecast.

Euro prepares for a mixed first quarter

The euro is likely to show mixed fortunes in the first quarter of 2024 as the currency looks set to post gains against the US dollar but may lose against the pound and especially against the yen. Economic data offers green shoots of hope until 2024 if the EU can avoid a recession like it did during 2023, if only that.

Does the recent rise in EU data indicate that the worst is behind us?

Sentiment and tough data are showing early signs of progress after rallying from the lows. One of the most shocking data on the continent in 2023 has been German manufacturing PMI numbers which are leading the rest of Europe on the way down. The data print is closely monitored since Germany is the economic powerhouse of Europe, so if the German economy suffers, the rest of the EU will likely suffer as well.

However, German manufacturing PMI data – while still deep in contraction – showed signs of improvement, rebounding from a low of 38.8. Other surveys such as the ZEW Economic Sentiment Index measure experts’ opinions on the direction of the European economy over the next six months, and have also risen from pessimistic lows in September 2023. Furthermore, the Economic Surprise Index has also risen from lower levels, suggesting that the EU has It will enjoy a period of relative stability if it can avoid recession.

ECB staff forecasts in December 2023 suggest a GDP growth rate of 0.8% in 2024, however, we could still see two consecutive quarters of negative growth in that time. Another possibility is that the EU is already in recession as we await Q4 GDP results after a 0.1% contraction in Q3.

A chart showing the recent rise in EU data side by side EUR/USD (blue)

Source: Refinitiv, prepared by Richard Snow

Smart Money reveals slight euro optimism ahead of Q1 2024

According to the latest Commodity Futures Trading Commission (CFTC) Commitment of Traders (CoT) report, hedge funds and other large financial institutions barely reduced euro long positions during the second half of 2023, while recent short positions were trimmed. Bullish charts reveal growing optimism around the euro as the market continues to price in the prospects of deeper interest rate cuts in the US, supporting the EUR/USD outlook.

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Long and short Euro positions according to CoT report 12/15/2023

Source: Refinitiv, prepared by Richard Snow

At the central bank’s final meeting of 2023, ECB President Christine Lagarde presented a tougher front on monetary policy than her counterpart and Fed Chairman Jerome Powell. Lagarde stated that interest rate cuts had not even been discussed and that interest rates may stabilize in the meantime, a sentiment echoed by the ECB’s Mueller and Villeroy shortly after the ECB meeting. The ECB’s latest forecasts suggest that inflation is likely to return to just 2% after 2025, and the Governing Council expects a slight rise in inflation in the short term – which could provide a tailwind for the euro in the first quarter.

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Accumulation of risks: expectations of inflation, growth and interest rates

Markets expect the ECB to cut interest rates at the same pace and scale as the Fed in 2024, and if that materializes, the euro is set to weaken across the board. The market is currently anticipating cuts of 150 basis points in 2024. Economic growth has really been at the heart of Europe’s woes, with China’s economic woes not helping the situation. If the economic situation in Europe deteriorates rapidly, the ECB may be forced to make those long-awaited interest rate cuts rather than enjoy a “plateau” where interest rates are expected to remain at high levels for some time.

Implied basis point discounts derived from overnight interest swaps

Source: Refinitiv, prepared by Richard Snow

Powell acknowledged the extent to which difficult financial conditions were affecting price pressures, noting that this would continue to impact activity. It’s very much a matter of who will blink first, and if you look at the data, the EU is more likely to succumb to economic headwinds than the US. This could lead to the euro reversing the gains it achieved towards the end of 2023.

Another concern is inflation, with the ECB expecting a slight rise in the short term, and the Fed emphasizing that it cannot rule out another rise in response to ongoing price pressures, although by its own admission, the US is likely close to peak prices. interest or then. .