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Bilal Hafeez, Research Analyst at Nomura, suggests that for much of this year, everything that could go wrong has gone wrong for the euro.

Key Quotes

“We’ve had terrible weather, worker strikes, a surge in oil prices (a big negative for the oil importing euro area), missed inflation targets and falling growth, US trade policy favouring American production of cars at the expense of the euro area, the worstcase Italian election outcome for markets, a simmering crisis in neighbouring Turkey and escalating Middle East tension. The only surprise would be that it took until mid-April for the euro to tumble.”

“Now, we have to ask whether we should exit the euro trade. Certainly, yesterday’s weak PMI prints for May question the thesis that the weather was the primary contributor to weak growth in Q1. And we shouldn’t forget that Italian risks don’t seem to be going away anytime soon.”

“But our hesitation in exiting the euro trade is that the pricing for ECB hikes next year has been lowered, while ECB rhetoric still appears to be in the direction of normalisation of policy. On top of that, next week we get the May print for inflation, which should see a sharp pick-up. Then on Italian risks, the euro’s correlation to Italian spreads has moved from consistently negative (that is higher spreads = lower euro) to more mixed since 2015. This is partly due to ECB measures that limited contagion risks across the bloc, but also the switch in the current account balance from neutral to surplus), which meant that euro-area investor repatriation could swamp any foreign investor outflows during a crisis. Given all this, we’ll wait for next week’s CPI print before deciding whether to exit.”