A Good Week For Euro Shorts

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Includes: DRR, ERO, EUFX, EUO, FXE, ULE, URR
by: Andrew Sachais

Summary

The euro area economy continues to deteriorate.

As it does, ECB policymakers will likely enact further stimulus in coming months.

This will weigh on the price of the euro, causing it to continue on its downtrend.

The euro looks to remain on its downward path as a week of utterly uninspiring data out of the currency bloc pushed the odds of monetary stimulus higher. CurrencyShares Euro Trust (NYSEARCA:FXE) is down over 15% since May, as is seen in the chart below.

The euro is vulnerable as German industrial production fell in November. The Industrial Production figure came in at a -0.5% annual pace for the month, declining from the previous month's revised reading of 1.2%. German industrial production fell from over 5% at the beginning of 2014, to now below 0%, as is seen in the chart below. Analysts are claiming that although European economic sentiment has risen the last few months, major downside risks are now clouding that optimism.

"The Bundesbank has said the German economy managed only a 'modest start' to the fourth quarter, after effectively stagnating in the prior six months. While surveys have shown that economic sentiment in the country is improving, the outlook is clouded by the euro area's struggle with sluggish growth, falling prices and Greek political instability," according to a report by Bloomberg.

Data provided by Trading Economics

Moreover, weakening economic activity among the euro area's top economies is weighing on inflation measures. In December, the annual pace of inflation came in at -0.2%, below the previous month's reading of 0.3%, as well as missing estimates for -0.1%. Since 2012, the euro area's pace of inflation has fallen from over 3%, to now deflation, as is seen in the chart below. While slowing economic activity has been a culprit of the slide in inflation pressure, so too has the drastic decline in energy prices the last few months.

"This negative rate is driven by a fall in energy prices [-6.3%, compared with -2.6% in November] while prices remain stable for food, alcohol and tobacco [0.0%, compared with 0.5% in November] and non-energy industrial goods (0.0%, compared with -0.1% in November)," according to a report by Trading Economics.

Data provided by Trading Economics

Lastly, the decline in the euro area's large services sector threatens economic growth in coming quarters. In December, the Markit Services PMI figure came in at 51.6, above the previous month's reading of 51.1, but missing estimates for 51.9. A reading above 50 signals expansion. The indicator began the year relatively well, increasing the first few months, but finished the second half of the year with consistent declines, as is seen in the chart below.

With the spiral lower in the services sector and German industrial output, as well as a deflationary scenario, the European Central Bank will likely enact a new form of stimulus in coming months. ECB president Mario Draghi said in a letter recently that he was awaiting the right moment to initiate further stimulus measures.

"[The ECB] will be particularly vigilant with regards to the broader impact of recent oil price developments on medium-term inflation trends in the euro area. Should it become necessary to further address risks of too prolonged a period of low inflation, the Governing Council is unanimous in its commitment to using additional unconventional instruments within its mandate," Draghi said in a report by Reuters.

Reuters also posted an article discussing what additional stimulus measures may look like.

"The main scenario for markets is that the ECB will join its U.S., Japanese and British peers in launching quantitative easing [QE] by buying government bonds in amounts proportionate to each euro zone state's shareholding in the bank," the Reuters report showed.

With the euro area economy continuing to deteriorate, additional stimulus measures seem more probable now. As ECB policy diverges from U.S. monetary policy, expect the euro to continue on its downward trajectory.

Data provided by Trading Economics

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The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.