FXE: Does Recent Economic Data Support A Stronger Euro?

About: Invesco CurrencyShares Euro Trust ETF (FXE), Includes: DEUR, DRR, ERO, EUFX, EUO, UEUR, ULE, URR
by: Sankalp Soni

The FXE ETF is down by about 10.15% from its 52-week high.

Eurozone's economic data continues to weaken, which could undermine Draghi's hawkish viewpoint.

There is a good chance of the ECB making a dovish shift in its monetary policy meeting on Dec. 13.

The Invesco Currency Shares Euro Currency (FXE) ETF, which tracks the Euro against the US Dollar, has declined by about 10.15% from its 52-week high. Euro bulls believe that the increasingly dovish US Federal Reserve and the simultaneous persistency in Mario Draghi’s hawkishness will result in the FXE ETF rallying higher. Draghi can only maintain his hawkish stance if the underlying Eurozone economic conditions can withstand tighter monetary policy conditions. This article assesses whether recent economic data can support upward movements in the FXE ETF.

Prospectus Review

The ETF tracks the value of the Euro against the US Dollar. The strategy does not involve the use of derivatives, but simply involves buying Euros using US Dollars. Consequently, the holdings of the fund do not include any futures or options, but simply consist of cash held in Euro. The annual expense ratio of the ETF is 0.40%.

Risk Note: The Trustee will sell euro held by the Trust to pay Trust expenses, if any, incurred in USD, irrespective of then-current euro prices. The Trust is not actively managed and no attempt will be made to buy or sell euro to protect against or to take advantage of fluctuations in the price of the euro. Consequently, if the Trust incurs expenses in USD, the Trust’s euro may be sold at a time when the euro price is low, resulting in a negative effect on the value of the Shares.

The reason I distinctively have chosen this ETF is because it is the only non-leveraged ETF that offers long exposure to the Euro. Other ETFs all incur leverage of at least x2. And given the uncertain outlook for both the Eurozone economy and monetary policy, I believe it is best to have non-leveraged exposure to the Euro in order to avoid any potential magnified losses. Moreover, according to data from ETFdb.com, the ETF has the highest average daily trading volume out of all ETFs that offer exposure to the Euro. Hence this enhances the liquidity profile of the fed, allowing investors to buy and sell shares in the ETF more easily, making it a safer investment option.

Retail sales confirm weak consumer confidence

On Dec. 5, retail sales for October released, which reflected year-over-year (yoy) growth of 1.70%. This missed the consensus estimate of 2.1%, however it is well above the drastic drop of the previous month to 0.3%. Nevertheless, the chart below shows how retail sales have been on a downward trend over the past year.

Source: Trading Economics

Moreover, the declining trend in retail sales confirms the negative sentiment among consumers, as the consumer confidence index dropped to -3.9 last week. Given that consumer spending is a significant driver of economic growth, this downward trend in retail sales is certainly a big concern, and could encourage Draghi to turn more dovish, pulling the Euro and the FXE ETF lower.

Purchasing Managers’ Index (PMI) declining

The manufacturing PMI for November came in at 51.8, beating the consensus estimate of 51.5. However, it was a decline from the previous month’s 52 level, and marked the weakest growth in the manufacturing sector since August 2016.

The services sector does not offer much to be positive about either, as while the Services PMI came in at 53.4, beating the consensus estimate of 53.1, it also fell from the previous month’s level of 53.7, confirming the downward trend over the past year, as demonstrated in the chart below.

Source: Trading Economics

Dovish Powell vs. Hawkish Draghi

It is important for FXE investors to also consider the currency against which the Euro is being tracked, the US Dollar. The US Federal Reserve has recently turned more dovish, which has weakened the outlook for the US Dollar. At the same time, Mario Draghi has maintained his hawkish viewpoint for monetary policy recently. This gives FXE investors a good reason to be bullish on the ETF. Nevertheless, given the continuous weakening of economic data coming out of the Eurozone, I do not believe any rally in the Euro will be sustainable, because at some point the ECB will be forced to turn more dovish, as more accommodative policies will be needed to support its economy. Consequently, this should weigh down any returns on the FXE ETF.

Bottom Line

Eurozone’s economic data continues to weaken. Hence I believe that there is a good chance the ECB may be encouraged to reflect a more dovish viewpoint following the monetary policy meeting on Dec. 13, 2018. Therefore, I presently do not recommend buying long positions on the FXE ETF.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.