EURO Gaining Strength over USD: What it Means for Emerging Markets?
The deep impact of Coronavirus pandemic on Europe was not a good omen for EURO as well and the currency was under serious pressure. Between 9th and 20th March, it lost ~7% against USD. Though there was a brief recovery in the following week, the Euro remained between 1.08 and 1.10 USD for most of April and first half of May. But this has changed in last fortnight and especially after 18th May (Fig. 1).
Fig. 1: EURUSD Forex Chart
On that day (18th May), Germany and France proposed a Recovery Fund, giving the EU more capacity to deal with this unprecedented shock. The immediate help is necessary to help those suffering most from the economic shock caused by COVID-19. The Angela Merkel and Emmanuel Macron proposal is important for two reasons. In near term, it helps in recovery because there is a plan to create an additional EUR500bn of EUR spending power, via an EU level borrowing.
However much more importantly, it gives enhanced visibility on the faith the more powerful countries have in the future of European Union. After the exit of United Kingdom from EU, the political leadership of Germany and France has more responsibility to pull the relatively weaker countries out of this quagmire and both Merkel and Macron have not disappointed. Naturally, it is good for Euro if the people are much more optimistic on the sustainability of economic union in Europe.
Ideally, a weaker USD is good news for Emerging Markets (EMs) currencies too. But the situation is less straight forward in this case. For the individual EM currency’s exchange rate movement will be more dependent on local economic issues these countries will face due to COVID-19. Some of them have announced generous economic packages and that will put pressure on fiscal deficit numbers, some have been impacted because of transport linkage disruption and because of their dependence of exports and some have local economies in peril because tourism has been badly affected.
Some countries would even prefer a stronger dollar because then their exports become more competitive. But this is an interesting development for the Emerging countries and overall, should not hurt them. Let us see how much more EU leaders can deliver and how much that will help the EU countries. There is some reluctance from a few of them to support a big package but when the bigger ones are showing intent, there is a likelihood that they will come around. As such, the benefits from these steps for EU are far higher compared to costs associated and a strong EU is not bad news for the financial markets in EMs too.
Another interesting angle to explore is that how does this link with overall market sentiment? When we look at the “topical sentiment” scores (Fig. 2), it clearly emphasizes the point that EURUSD and weak dollar have sent the overall sentiment soaring. As expected, Trump sentiment is very negative. But, for the first time that we have seen, the rest of the sentiments are all bright!
Fig. 2: EMAlpha “News topical sentiment”
Coming back to EURUSD, you may argue that this might not be the only reason but when you see a hugely positive sentiment for “S&P 500 Index” and corroborates this with underlying news, this surely has been an important factor.
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