Euro Vulnerable As Slowing Growth Reveals Underlying Issues

In our last commentary on the euro in late August, we wrote that the common currency was set to weaken further thanks to (1) slowing growth, (2) slowing inflation and (3) an outsized speculator long position in euro futures and options. Following the publication of our last commentary, EUR/USD has weakened from 1.1730 – 1.180 (the top-end of its trading range that we update daily on our website) down to 1.1510 (the current price on October 4).

When the euro rallied last year, speculators were happy to ignore the region’s many underlying economic issues. Looking at the data, year-over-year GDP growth accelerated from 1.9% in Q1 2017 to 2.7% Q4 2017. Remarkably, the Eurozone grew at a faster clip in late 2017 relative to even the United States. Thanks to the euro’s ‘risk on’ qualities, the currency tends to strengthen in response to accelerating economic growth in the region.

Following many quarters of significant gains, few expected a slowdown. Note that we warned Eurozone growth was set to deteriorate significantly last April (just before the euro began weakening). Looking ahead, we expect the deteriorating downturn to reveal significant issues in the Eurozone. Specifically, the Eurozone is increasingly vulnerable thanks to rising debts, weak demographics and an excessive reliance on its trade surplus (particularly with the United States and the United Kingdom). As economic data from the region continues to deteriorate, expect these issues to dominate investor concerns.

Eurozone economic data continues to deteriorate

As described above, the euro is a ‘risk on’ currency that broadly tracks Eurozone growth in rate-of-change terms. After peaking in Q4 2017, year-over-year growth in the region has slowed to 2.2% in Q2 2017 (shown below). Forward-looking economic indicators that have historically foreshadowed changes in growth trends, such as manufacturing sentiment, have also weakened sharply in recent history. An overview of Eurozone GDP growth and manufacturing PMIs are shown below: