- A long and bumpy road ahead for approval of EU recovery fund.
- Headwinds are still lingering which could support safe haven demand.
- The next US treasury report may limit further FX intervention.
Last week, we have witnessed EUR outperform against most of its G10 peers which could be attributed to month end flow dynamics, weaker US Dollar as well as the optimism arising from the European Union (EU) Commission's EUR750 billion recovery fund which aims to help the bloc to recover from the coronavirus crisis. This article aims to discuss why the recent rally might be short lived and should instead fade any EUR rallies moving forward.
A long and bumpy road ahead for approval of EU recovery fund
In terms of the latest development regarding the EU recovery fund, according to the European Commission (EC) the recovery plan will be rolled out under three main pillars. Firstly, it would be supporting member states to recover and the main bulk of the funding, more than 80%, will be used to support public investment and key structural reforms concentrated on where the crisis impact and resilience needs are the largest. Secondly, it will be focusing on mobilizing private investments in key sectors and technologies which would be pivotal to the success of Europe's green and digital transactions. Lastly, the plan would also reinforce programs for research, innovation and external action and supporting key programs for future crises. While the proposal might be viewed favorably by EUR bulls, it is still too early as the process of getting approvals and forming an unanimous agreement among the countries might be an uphill task, especially regarding financing and allocation issues among countries. The European Commission did consider the current difficult financial and budgetary situation of many member states and funding to be raised through loans, many of which have long-term maturities and will be paid back through new resources such as the Emissions Trading System, carbon and digital taxes. However, taxation is something that requires unanimity and should no agreement on taxes is to be found, the method of financing might possibly revert back to contributions from members states. Furthermore, the 'Frugal Four' has previously voiced objections to EC plan and should things get messy and further objections are raised down the road, it might potentially cause a stall in the recent EUR rally and suggest fading any EUR rallies going forward until further clarity and amicable agreement among countries could be reached.
Headwinds are still lingering which could support safe haven demand
Moving into the US and China relationships, things get even more complicated than it was previously. We did see Trump mentioning sanctions against both Chinese and Hong Kong officials, limiting the number of visas for certain Chinese students as well as removing some of Hong Kong's privileged trade status. This is further compounded by the fact that the ongoing coronavirus crisis coupled with the unresolved US and China tensions makes things even more uncertain on how events could potentially play out. While risks and uncertainties still linger, it is still too early to rule out further escalations and this could potentially lead to demand for safe havens such as the Swiss Franc.
The next US treasury report may limit further FX intervention
We have seen that the Swiss National Bank (SNB) has actually been actively intervening the FX market to smooth out the appreciation of the Swiss Franc with the sight deposits as a proxy for SNB foreign currency intervention ticking higher during the May period as seen in Figure 1.
That said, the question is how much more could the Swiss National Bank actually intervene in the FX market considering Switzerland is in the monitoring list in the US Treasury Report. Based on the US Treasury Report released in January 2020, Switzerland has met two of the three criteria for currency manipulation 1) A significant bilateral trade surplus with the United States and 2) A material current account surplus (One that is at least 2% of gross domestic product (GDP) over a 12-month period) as seen in Figure 2.
Hence, Switzerland is in a danger of being labelled as a currency manipulator based on the criteria set by the US Treasury and the fact that the second semiannual report has yet to be released suggests the Swiss National Bank could potentially slow down the intervention of the highly valued franc which should keep EUR/CHF upside limited going forward.
To conclude, while the proposal of the EU recovery fund might paint a rosy picture for EUR bulls going forward, the possibility of debate among EU members could lead to a long and bumpy road which still cannot be ruled out at this phase. In addition, the lingering headwinds and uncertainties within the macro space as well as the release of the next US Treasury Report could potentially lead to EUR/CHF upside contained and instead should fade any EUR/CHF rallies moving forward.
This article was written by
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