Trouble brewing in the eurozone

Dion Rabouin

WASHINGTON DC: Increasing lockdowns, a mutating virus and a botched vaccine rollout have the eurozone headed for a double-dip recession, weighing heavily on its currency and pushing the dollar higher.

Why it matters: The weak dollar (down 10% from its 2020 highs) has been a linchpin for some of the biggest consensus trades this year — strong commodities, skyrocketing U.S. equity prices and emerging market stocks and bonds.

A weakening euro — the largest component in the value of the dollar index — means a stronger dollar, which could halt or reverse those trades.

The economic slowdown could force the hand of the European Central Bank to further lower interest rates below -0.5% or deliver even more extreme monetary policy easing, further weighing on the euro.

The big picture: The ongoing crisis in the eurozone — where GDP in the fourth quarter was -0.7% and economists are predicting another quarter of negative growth for Q1 this year — is running in direct opposition to the bounceback seen in the U.S., which boasted 4% growth in Q4.

Bank of America Securities notes that the euro has been one of the “greatest underperformers” among the world’s major currencies.

Kathy Lien, managing director of FX strategy for BK Asset Management, pointed out in a note to clients that the euro extended its fall against the dollar despite better than expected economic data earlier this week, “which goes to show that once sentiment shifts, it can have a lasting impact on a currency.”

By the numbers: The euro has fallen for three straight days and touched its lowest against the dollar since Nov. 30 on Wednesday.

The continental currency also hit its weakest against the British pound in nine months.

Between the lines: While growth has been nonexistent, signs of inflation have been popping up, pushing government bond yields higher.

a. Most recently, eurozone consumer price inflation hit an 11-month high of 0.9% in January, up from -0.3% in December, according to Eurostat. That was the biggest inflation jump in more than a decade.

b. Core CPI rose by 1.4% on the year.

Eurozone PMIs were revised higher in the month of January but remained below 50 for a composite of the manufacturing and services sectors, with services as the biggest drag, having fallen for five months straight.

1. Overall private sector output declined for the third consecutive month and at an accelerated rate, IHS Markit reported.
2. Ireland’s composite PMI fell to its lowest level in eight months.
3. Germany’s fell to its lowest in seven months.
4. Italy fell to its lowest in three months and Spain and France both fell to their lowest in two months.

The other side: U.S. services and manufacturing both jumped in January, with the services sector reporting especially strong growth.

a. “The rate of growth was the second-sharpest in almost six years, with firms linking the upturn to stronger client demand and an increase in new business,” IHS Markit noted in a release.

b. “January data indicated a strong rise in new orders.”

What to watch: IHS Markit also highlighted a notable pick up in U.S. businesses’ costs — another sign of creeping inflation.

“[C]ost burdens soared once again, with the rate of input price inflation the fastest since the survey began in 2009. Firms largely passed on higher costs to clients through a marked rise in charges.”