Things changed completely over the past two months for the most popular FX pair. After almost reaching the 1.06 area in March, the price had rebounded impulsively, currently sitting around 1.12. Few market participants were expecting such a performance, especially if we think about the structural issues of the Euro Area. As always, the least-discounted event happened, with a few important reasons behind, needed to be discussed.
EU rescue plan
The market is now ignoring any potential downside risks for the FX market during the summer, mainly because recently, the European Commission had proposed a 750 billion rescue plan to counteract the negative effects of the COVID-19 pandemic. The plan is still up to debate and all countries will need to agree on the terms. However, the fact that 500 billion represent grants plus some of the funds might be raised using Eurobonds, represents a key change in how EU country members want to move forward. This all came during a period when the infection rate dropped and economies were already started to reopen.
Market flushed with USD
What happened in the first half of March was mainly due to a US dollar shortage. The Federal Reserve stepped in aggressively, crossed many red lines (as chairman Jerome Powell himself acknowledged), and at least in the short-term, managed to ease the pressure on the US dollar. The DXY, which is the dollar index, topped at 103 and currently trades around 97.45. Even though the dollar remains relatively strong against other currencies, in the short-term some relief is noticeable. Flooding the market with liquidity had been the approach of all central banks, but the longer-term effectiveness is still under a question mark.
Longer-term risks to watch
At some point in the future, risk will spike again, since the pandemic will create numerous economic challenges in the years to come. Timing would be very important to anticipate correctly how the market would move, but in the meantime, we continue to benefit from this increased risk appetite.
As for the long-term risks, investors will monitor if the second wave of infections will show. At the same time, companies will have very low revenue, creating a balance sheet recession. Some of them will go bankrupt, as it happens during an economic downturn, but how great the impact will be is to be monitored. The market is discounting a V-shaped recovery right now, but the odds of not encountering bumps along the way are still very low.