Euro loses its luster as second wave grips Europe; Can the rally be restored?

Not so long ago it was all about the eurozone economy and the single currency could not take a wrong step. After being ravaged in the spring by the surge in deaths from COVID-19 and an economically deadly lockdown, Europe had started to tidy up its house in late May. Cases of the virus were declining, businesses were allowed to reopen and European leaders showed a rare display of unity when they agreed on a historic virus relief fund. But as infections start to rise again and companies struggle to make ends meet with new restrictions, the euro could head into more stormy waters in the coming colder months.One euro in retirement

The euro was down for much of September, retreating to the $ 1.16 grip and reducing its year-to-date gains against the mighty US dollar by 7% to around 4%. In reality, however, the uptrend had started to collide long before the pair peaked at $ 1.2011 on September 1. soon.

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The loss of momentum coincides with steadily deteriorating Eurozone data and with the US economy ignoring forecasts of a major blow from the second wave of the US virus. But while problems are mounting in the United States as well – mainly because politicians are too concerned about the upcoming presidential election to sit down and compromise on a new budget package – these risk factors have been positive for the government. dollar because of its safe haven status.

Election and viral risks drive the dollar up

Risks surrounding the US election, the prospect of no further fiscal stimulus, and the possibility that the resurgence of the virus in Europe could still force national lockdowns are unlikely to dissipate in the coming weeks. This means that the greenback will likely remain high at least until election day on November 3, making it difficult for the euro to stage a comeback before then.

Of course, the longer the euro consolidation lasts, the more likely the euro bulls are to become discouraged. But that doesn’t seem to be the case yet. Long positions in the euro fell only slightly from record highs. Add to this the fact that the 10-year spread between German and US sovereign bonds has remained stable within a range since March, when the Fed cut rates to near zero, there are good reasons why the euro resumes its rally at some point in the coming months. At the very least, there is not much to support a sharp bearish correction in the euro / dollar.

As the pair gets through this period of uncertainty, the main downside tests will be the 50% and 61.8% Fibonacci retracement levels of the June to September bullish leg at $ 1.1589 and $ 1.1489. , respectively. Preventing declines beyond these key levels could be critical for how quickly the euro is able to restore a more optimistic posture.

The escalation of the virus weighs on the euro

The rate of coronavirus infection in major eurozone economies is currently a major driver of sentiment for the single currency. Daily cases of the virus continue to rise in Spain, France, Belgium and the Netherlands, although they remain under control in Germany and Italy. A stabilization in the infection rate could help the euro regain a positive footing, as further escalation of the virus can only reinforce expectations that the eurozone’s recovery is about to derail. So far, no full lockdown is envisaged in any of these countries, but that could change if health services were inundated by an explosion in hospital admissions.

The negative impact of a hesitant economic rebound on the euro / dollar would be even more serious if the US recovery did not follow the same fate. But it’s not just the comparative bug and economic data that will determine the direction the euro / dollar will take as Europe’s second wave unfolds. Who wins the election in the United States and perhaps more importantly, if the election outcome is disputed, could be just as crucial for the euro as it is for the greenback.

Is the dollar set for post-election losses?

In recent weeks, investors have sharply downgraded their assumption that a Democratic president would be bad for the economy. As it stands, markets see a greater chance that another major virus relief program will be approved if Democrats occupy the White House or take control of the Senate. A further dose of fiscal stimulus would trigger a slowdown in the recovery in the United States and stimulate global risk appetite, but not necessarily the dollar, which would likely be under pressure from lower safe-haven flows.

If President Trump gets a second term and the Republican Party maintains its grip on the Senate, post-election fiscal policy would not be as flexible, but there would be less threat of tax hikes and tighter regulation on down the line. So markets could be happy either way, and the dollar could slide in either scenario as the uncertainty subsides.

A weaker dollar after the election would be exactly what the euro needs to generate further bullish momentum and climb above its short-term moving averages (MA). A bearish cross is currently underway between the 20 and 50 day MAs with the $ 1.1780 area being the point of intersection. This is the closest key resistance the Euro / Dollar must overcome to eliminate downside risk, but the biggest challenge is the high of 1.2011 which must be broken if the pair is to restore its bullish trend.

US election crisis could wipe out euro rally

However, as the presidential race seems so close and Trump suggests he could challenge the election result in court if he loses, there is growing fear that he may refuse to step down quietly. , plunging the country into a constitutional crisis. Such a prospect would be detrimental to the sense of fragile risk underlying the markets at the moment and the euro could find itself stuck in a phase of consolidation for an extended period.

ECB vs Fed: who will relax the most?

Beyond the election, however, there is another pressing question and that is whether further monetary stimulus is planned by the European Central Bank and the Federal Reserve. The two central banks will likely have to decide before the end of the year whether to step up their stimulus programs. There is already some concern within the ECB about expanding the pandemic asset purchase program as the Fed is almost certain to step up its purchases if hopes of a US budget package fall at the water.

Therefore, a relatively more hawkish ECB could be what will ultimately define the next trajectory of the single currency and it may not be a stretch to expect the euro / dollar to return to a trading range of. $ 1.22 to $ 1.25 in 2021.

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