The European Central Bank in the crosshairs

Two problems are immediately clear. First of all, budget questions at a European level require unanimous support from member countries. Even if the so-called ‘frugal four’ (Sweden, Austria, the Netherlands, and Denmark) do not reject the Commission’s proposal en masse, there will certainly have to be concessions to obtain their final endorsement (such as reducing the total amount of the fund or including a budget control measure for countries from the South, among others). Secondly, time is not on Europe’s side. The political negotiations starting now will last until July in a best-case scenario and may extend until the autumn if Chancellor Angela Merkel is to be believed. Drawn out negotiations send a bad signal and highlight the difficulty Europe has in advancing rapidly during a crisis. While the EU is still discussing its first recovery plan, Singapore unveiled its fourth recovery plan last week.

Clearly, the more Europe delays action and injections of billions to support the most struggling economies, the slower the recovery will be and the more the exchange rate for the euro will suffer in the long run.

Geopolitical risk

Another factor that could weigh against the euro is the ever-increasing geopolitical risk. Our analysis from last Monday spoke of this very issue. Since then, Chinese-American tensions have only grown with the Hong Kong situation at the crux of the friction between them. The American government is revoking Hong Kong’s special trade status due to its loss of autonomy. China responded immediately, calling it ‘the most barbaric, the most unreasonable, and the most shameless’ decision. Up to this point, exchange markets have reacted very little, almost certainly because of all of the attention being paid to the coronavirus crisis. If, however, tensions shift to Taiwan as we fear they might, it could constitute an important escalation between Washington and Beijing that could lead to a rapid turn to safe haven currencies (with the American dollar and Japanese yen at the top of the list). As summer approaches, one bleak scenario is a brutal escalation of geopolitical tensions--which is not rare in July and August when volumes are at their lowest--that could incite China to let the yuan exchange rate slide even more, potentially causing massive repercussions on exchange markets.

Policies of major central banks

In the short term, foreign exchange dealers will be focused on central banks once again in the coming days. The Bank of Canada is expected to maintain its monetary policy without altering it. The European Central Bank (ECB) is expected to announce on Thursday that it will strengthen its measures for supporting the economy. We foresee the emergency purchase programme to combat the pandemic (originally 750 billion euros) increasing by 500 billion euros to 1,250 billion euros so that the ECB will be able to absorb all of the new sovereign debt issued to deal with expenses relating to the coronavirus. It is also probable that the programme will be extended in length from the end of 2020 to mid-2021. An announcement of this change has already been integrated into market exchange rates. Any unexpected measures that may be announced, for example regarding the provision of credit to banks, could risk causing increased volatility in EUR pairs Thursday afternoon.

Economic calendar