Does The COVID-19 Crisis Threaten The Euro-Zone?

Trading Tips

Echoes of Former Crises

The Current crisis stemming from the ongoing spread of COVID-19 has once again shone a light on the tensions within the Euro-zone and the fault lines which run through the European project. Such episodes are not uncommon for the Euro-zone, even looking back beyond the most recent Brexit situation, we saw similar tensions during the 2015 standoff between Greece and the EU and, beyond that, during the sovereign debt crisis of 2011/2012.

The current situation is somewhat different in that, instead of involving just one or even a hand-full of Euro-zone member states, the whole of the Euro-zone is caught up in this crisis, as is the whole world. While we have seen a number of policy reactions from various Euro-zone governments so far, there is yet to be a unified approach to handling the situation.

The failure of the “coronabond” talks earlier this week, once again highlights the divisions running through the Euro-zone, particularly between the Northern and Southern states. The concept of debt mutualisation has long been a sore topic within the Euro-zone with the more prosperous states such as Germany balking at the idea of accruing debt to help out what they class as the more economically irresponsible states such as Greece and Italy.

The current situation, which looks set to continue at least over the next month or so, could prove the biggest challenge for the Euro-zone since inception. Such difficulties are likely to be reflected in a lower path for EUR. The divisions and obstacles within the Euro-zone serve only to further endorse the view of the US Dollar as the global reserve currency.

Investors Much Calmer (For Now)

Interestingly, there seems to be much less concern among investors with regards to the integrity of the European project than during past episodes. The Sentix survey of investors (which measures the projected probabilities of Euro-zone countries exiting the EZ within the next 12 months) is at a very low level compared to the readings given during the 2015 and 2011 risk events. However, this is not to say that we won’t see the level rise in coming months, particularly if talks around financial aid for struggling Euro-zone economies become more fraught.

The current calm with regards to the potential for the crisis to cause the breakup of the Euro-zone can likely be explained by the fact that, having weathered previous episodes both investors and governments alike have more faith in the strength of the Euro-zone. We have not seen the dramatic pressure on periphery bonds which we have seen during prior episodes, nor have we seen the cratering of the EUR.

Why is EUR Not Selling Off?

In terms of EUR price action specifically, the lack of significant downside here can likely be explained by the fact that traders have been holding net-short positions in EUR for sometime now, and in good size at certain points, limiting the scope for downside here. Furthermore, given that EUR has become a favourite funding currency for risk-on trades, the sharp drop in risk appetite over the last month means that traders have been cutting their higher-yielding positions and buying back EUR shorts, keeping the single currency supported.

Technical View

EURJPY (Bullish above 122.97)

From a technical viewpoint. Price action in EURJPY is well worth watching on the weekly time-frame here. Price is potentially carving out a large double-bottom, with bullish momentum divergence. The key challenge for the pattern will be the cluster of resistance around the yearly pivot ( 121.79) 2020 highs (122.97) and bearish trend line around the same area, with VWAP coming in just above. If price breaks above that region this could signal the start of a major trend change for EURJPY.

Does The COVID-19 Crisis Threaten The Euro-Zone?

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

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