EUR/USD: Consolidation Likely To Follow Gains

Summary

• The EUR/USD has seen a rebound to the upside this month.
• Nonetheless, deflation in the euro area remains a concern.
• I envisage that the currency will consolidate around the 1.10 mark going forward.

Last month, I made the argument as to why I maintained a bearish view on the EUR/USD.

With a German court ruling that the ECB had not acted proportionally in its asset purchase programs – this would limit the ability of the Bundesbank to continue participating in the central bank’s asset purchase programs.

However, this does not appear to have had the negative effect on the euro that markets might have initially expected. In the past month, the EUR/USD is up to 1.1378 at the time of writing.

Source: investing.com

Brexit has been eclipsed by COVID-19 this year, but it still remains an important consideration nonetheless. Specifically, Britain reportedly has until the end of June to extend the deadline in the case that a deal cannot be reached – otherwise Britain will start trading with the EUR on WTO terms come 2021. In this regard, the true Brexit may yet still be on the way.

However, the British government has been very forthright that an extension will not take place. More specifically, with the economic fallout from COVID-19 and the associated drop in travel and cross-border trade, there may well be a growing sentiment that the UK now has effectively nothing to lose by opting for a no-deal, which serves the aim of allowing that country to have maximum flexibility in negotiating new trade deals with other nations.

From this point of view, I do not see much risk that the EUR/GBP will necessarily decline by a great deal from this point, if at all. We have seen the EUR/GBP rise even more significantly than the EUR/USD in the past month:

Source: investing.com

With the economic impact of COVID-19 becoming clear – it is also quite possible that markets have already priced in a no-deal into the currency. While there was significant concern that a no-deal would threaten economic growth, particularly for the United Kingdom, this concern now pales in comparison to the fallout from COVID-19.

From the European side, concern over the economic effects of COVID-19 continue. Specifically, the prospect of deflation is being considered by the ECB and whether the Euro area will ultimately require monetary stimulus to combat this going forward.

Deflation is a concern since consumers will stop spending in anticipation of lower prices over the longer-term. Under such a scenario, demand for the euro will fall and the currency would be expected to decline. With that being said, further monetary stimulus also risks the opposite problem – excessive inflation if the economy recovers more quickly than expected and consumers take advantage of low rates. Inflation would also place downward pressure on the euro under such a scenario.

At one point, I had stated that the euro could see parity with the greenback by the end of this year as a result of pressures due to COVID-19. The currency has shown resilience, and given how the virus has affected the United States both in terms of the number of deaths and the associated economic fallout, I do not see this as a likely possibility going forward. That said, my view is that the EUR/USD does not have much room left to rise from here and we could see a consolidation at around the 1.10 level going forward.

Analyst’s 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.