Investors continued to sell euros on Wednesday, driving the currency to its weakest level since July. Europe’s greatest fear is materializing with the number of coronavirus cases exceeding 5 million. As we indicated at the start of the week, stricter restrictions are on their way. France introduced a color-coded map of hot spots and restrictions on gatherings along with reducing opening hours for bars and cafés in an attempt to slow the virus spread. No one is willing to return to the hard lockdowns that were in place in the spring, but even smaller measures like these will curtail growth. We’re already beginning to see a slowdown in the recovery, with service sector activity slowing across the region. Manufacturing activity is up, but the improvement was not enough to nudge the composite index for Germany, France and the Eurozone higher. The Eurozone composite PMI index dropped to 50.1 from 51.9, which means the region’s economy basically stagnated in September. There’s no doubt that this second wave will cause the recovery to slow further. According to ECB member Yves Mersch, the recovery path might be a bit closer to a mild scenario.
At the beginning of the week, when EUR/USD was trading on the 1.18 handle, we said it could fall as low as 1.15. Today’s decline marks the fourth straight day of losses for the currency pair and, on a technical basis, there’s minor support between 1.1625 and 1.1650. Beyond that, it's all clear down to 1.15. Germany’s IFO report is scheduled for release tomorrow, and the decline in PMIs signal potential deterioration in business sentiment.
While Europe’s troubles played a key role in the currency’s weakness, the primary story continues to be demand for U.S. dollars. Stocks turned lower after starting the day in positive territory, and this reversal drove investors into the greenback. The dollar traded higher against all of the major currencies except for sterling. Markit PMIs were mixed, with manufacturing activity accelerating but service sector activity slowing, which led to a decline in the composite index. The dollar took its cue from Fed speak. Fed Chairman Jerome Powell spoke again today along with presidents Richard Clarida, Loretta Mester, Charles Evans and Eric Rosengren. Powell’s opening remarks were identical to yesterday’s, but today he added that the bank has basically done all of the things it can think of. Clarida expects the Fed to keep rates low for longer, at least until inflation hits 2%, and policy should aim for a moderate overshoot. Mester said 2.5% inflation is in the cards, which means they could keep rates unchanged until prices are much higher. Rosengren fears a second wave and says he’s less optimistic than other Fed forecasters as he believes “we’d be lucky” to get 2% inflation in next three years. The doves were out in droves today but the dollar was unfazed, as the greenback tracks the rise in Treasury yields.
The worst-performing currencies were the Australian and New Zealand dollars, which fell to fresh one-month lows versus the greenback. There was no specific economic reports released from Australia, but as a risk currency and a country embroiled in troubles with China, buyers have disappeared quickly. While the Reserve Bank of New Zealand left interest rates unchanged, it said it is prepared to provide additional stimulus. What the central bank is telling us is that beating out COVID-19 doesn’t mean an automatic economic recovery. They see unemployment rising and more firms closing. The balance of risks remains to the downside and for this reason, negative interest rates and funding for banks are potential tools for more stimulus. Meanwhile Canadian Prime Minister Justin Trudeau’s promise for dramatic actions to stimulate the economy helped to stem the slide in the Canadian dollar.
The best performing currency today was sterling, which shrugged off weaker service and manufacturing PMI. Virus cases are on the rise, but talk of extending the furlough scheme may be helping the currency.