Euro exchange rates could be teetering on the brink of a more notable shift lower as a growing new wave of covid-19 infections grip Eurozone countries, leaving the region’s services sector at risk of permanent scarring.
COVID-19 Infections Risk on Economy
The rise in COVID infections will likely require governments to implement further restrictions that could hit sentiment and activity in the region, requiring further interventions from the European Central Bank (ECB) which traditionally lead to declines in the value of the region’s single currency.
And all this comes at a time when investors stubbornly hold onto Euros in the expectation that it will rise.
According to analysis by investment bank BNY Mellon, sentiment on the Euro is now considered extreme as investors are still sitting on an oversized bet for Euro upside despite developments in the economy.
The foreign exchange playbook suggests that when sentiment and positioning reach an extreme level,s there is a heightened risk that a capitulation ensues, leading to a sizeable corrective move lower.
“As the charts below from iFlow show, EUR is now the most overheld currency in G10 and with a score of over 2.0: we would even characterize EUR holdings now as extreme,” says Geoff Yu, Senior EMEA Market Strategist at BNY Mellon.
iFlow is BNY Mellon’s custom flows observation tool that gives analysts insights into where investors are sending money and gives insights into how various sectors and financial assets might perform in the future as a result of these flows.
The Euro has already come under some pressure of late, with the Euro-to-Dollar exchange rate (EUR/USD) falling back below 1.20 in March to quote at 1.1800 at the time of publication.
But there is now a risk that this move lower accelerates as the Eurozone’s deteriorating sentiment meets a potentially over-held Euro.
Referencing the investor community’s holdings of Euros, Yu says “these positions are not profitable and need little encouragement to be taken off.”
Covid-19 infections in the Eurozone remain a concern to authorities with Germany – the region’s economic engine – looking particularly sensitive to the virus.
“In Germany, all indicators now point to a significantly stronger spread of the coronavirus. In the past week, the proportion of positive tests has also increased significantly,” says Bernd Weidensteiner, Senior Economist at Commerzbank.
Weidensteiner explains that the 7-day incidence published daily by the German RKI – i.e. the total number of people who have contracted Corona in the past seven days – plays a major role in politics. Whether shops open or close depends on this value, according to the decision of 3 March.
Yesterday it stood at 113.3 per 100,000 inhabitants, up 5.2 from Tuesday.
Yet Chancellor Angela Merkel on Wednesday performed a seismic u-turn by reversing a decision to tighten restrictions over Easter. The decision could lead to the requirement for a more severe and longer-lasting lockdown in the future if cases start to runaway which in turn poses significant risks for the economy.
In France, the number of infections continues to rise and in the past seven days almost 50 new infections per 100,000 were reported, 11 more than a week ago.
The country has already announced new restrictions on movement.
“Despite the litany of negative headlines of late, especially on vaccinations and lockdowns, the euro has managed to hold its ground. If the FX market chooses to move away from following the whims of US yields in the coming weeks and allow idiosyncratic factors to drive price action, the euro certainly is outperforming its fundamentals,” says Yu.