More vulnerability for euro

The euro will probably continue to dance to the tune of gas prices and not much else will matter.

Currency markets are nothing if not fashionable. The factors that appear to be driving currencies come and go like fashion. What seems to be driving a currency today might not be doing so tomorrow, or in a week’s time and, almost certainly not in a year’s time. So, when it comes to short-term currency forecasting over weeks and perhaps months, we need to know what the latest fashion is and, hopefully, where it might lead currencies. Right now, if we look at the latest fashion, it seems to spell difficulty for the euro.

The “fashion” that seems to have the most profound impact on the market at the moment comes from the impact of movements in European gas prices on the euro. Some traders and investors might think that’s wrong; that other factors such as the monetary policy of the ECB, or the Fed, are the key.

However, while analysts and the press devote reams and reams of column space to Fed and ECB policy, there’s actually little evidence that their policies are moving currencies very much, if at all. For instance, take the ECB meeting last week. Before that meeting, the ECB had hinted very strongly indeed that the key policy rate would be lifted by 25-bps.

As a result, market pricing was clearly geared to a hike of this size. The 50-bps hike that materialised was definitely not priced into the curve and not anticipated by most analysts beforehand (85% of the 45 analysts in the Bloomberg survey predicted a rise of 25-bps).

And yet, in spite of this big surprise, the euro hardly budged and, today, is lower than when the ECB announced the rate hike. In Mr.Steve Barrow, Head of Standard Bank G10 Strategy’s view, the reason it is lower today is because Russia has cut back gas supplies to Europe which has sent European gas prices rocketing again. Originally, when there was a big spike in gas prices last December, the euro hardly budged. But as the war in Ukraine started and gas prices surged again, so the euro has become more sensitive and now it seems such high fashion that the euro literally twists and turns with every movement in the gas price.

For forecasters, this creates some clarity, but also some problems. Clarity in the sense that it is very obvious at the moment what is driving the euro, as opposed to the mish-mash of factors that might normally be in play. But difficulty because short-term forecasting of the euro becomes short-term forecasting of gas prices instead. If this were easy then it might make forecasting the euro easier as well.

However, it is not given the apparent role that politics is playing in the supply of gas to Europe. In addition, Mr.Steve Barrow doesn’t know how long this “fashion” will last. At some point the market will forget all about this factor as an influence over currencies just as it has forgot about Covid-19 and the myriad of other “fashions” we have seen over the years.

Covid-19 ceased to be a major factor for currencies because a vaccine was found. Gas supply from Russia will eventually fall off the markets radar screen, because Europe will get its supply from elsewhere. But that won’t be quick, just as it took some time to get populations vaccinated against Covid. So, for now at least, the euro will probably continue to dance to the tune of gas prices and not much else will matter.

If that’s the case, what does the short-term future look like? Mr.Steve Barrow said if Russia is manoeuvring supplies deliberately to squeeze Europe, and the EU in particular, then it seems likely that prices will continue to surge and the euro slump. If, on the other hand, reductions in supply are purely based on maintenance issues then the euro could stabilise and perhaps rebound if supplies increase again.

“We tend to lean more to the former view and we suspect that the markets sympathies lie in this direction as well and, as a result of this, there will be significant wariness in buying “cheap” euros right now. Our 3-month target of 0.95 for euro/dollar acknowledges these risks, but the euro might actually prove more vulnerable against currencies that have not already rallied against the single currency – like the yen”, said Mr.Steve Barrow.