Amongst U.S. Dollar strength across the board coming into 2021, the Euro has come roaring back on further optimism on the vaccine, alongside asset markets strength.
There has been a clear downtrend from February's start, following a clean channel downwards towards 1.195. However, around the 6th of Feb, the pair broke out of the downwards channel on the news that former ECB President, Mario Draghi, was tapped to form a party to lead Italy out of the two crises they faced themselves in – financial recession and the Coronavirus.
Mario Draghi was known for convincing European leaders to take extraordinary measures to save the European Union by implementing controversial monetary policy at negative rates. He emphasized that "for rates to be positive later, they need to be negative today."
But the Coronavirus situation has placed a wrench in that thesis, requiring monetary policy that the ECB doesn't have to give. Nevertheless, he left the ECB in 2019 with a glowing reputation, attaining the nickname "Super Mario." Analysts are cautiously optimistic that Draghi can pull Italy out of their predicament as he did with the Euro.
ECB's Current President, Christine Lagarde, predicted that the recovery in Europe would pick up in the summer, as vaccines roll out across the continent. However, the vaccine rollout in Europe has not come to a good start, with only 3.6% of the continent receiving their first shot. This is in comparison to around 17% of citizens in the U.K. receiving their first shot. Lagarde stated that "We remain convinced that 2021 will be a recovery year" and that "the economic recovery has been delayed, but not derailed. People are obviously waiting impatiently for it."
Currently, optimism on Mario Draghi's appointment has fueled the rise in the Euro, alongside a slight weakness in the U.S. Dollar. However, Europe needs to curb the virus faster than the U.S. does for the Euro to go past 1.23.
If there is a time for a currency to be relatively weak, it's during recessionary periods. A stronger currency entails a rougher time for goods and services to be exported out of the country as those exports are more expensive due to the stronger currency.
This is currently the case for the Euro. From August last year to the latter part of 2020, the EUR/USD fluctuated between 1.16 and 1.19 before shooting past 1.20 at the end of November due to vaccine positivity.
It sits comfortably above 1.20, consolidating between 1.205 and 1.233. Christine Lagarde, President of the European Central Bank (ECB), has a dilemma on her hands: how to contain the strength of the Euro due to positive sentiment while fighting deflation concerns?
Theoretically, it could be argued that the ECB has used up all their ammunition when it comes to monetary policy.
With Interest Rates at 0% for the past four years, alongside the Coronavirus pulling on both sides, with lockdowns forcing businesses to close and consumers to save, a liquidity trap may be underway. The strength of the Euro also gives the ECB limited room to move rates lower. This harks back to the Bank of Japan's issue during the financial crisis, with analysts predicting disinflation, therefore boosting the Yen, thus boosting fears of inflation - a never-ending cycle.
The ECB has purchased over 1.85 Trillion Euros worth of assets during the wake of the Pandemic. However, we may see a situation unfold similar to that of the Fed and US Equities – where the Fed's unwavering support for the US economy has had the side effect of boosting US equities. Further purchases may see an influx of capital in European Equities, increasing the demand for the Euro.
Since the strength of a currency is relative, some analysts predict the only way for the ECB to escape the cycle of a strengthening currency and deflationary concerns is through outperforming the Fed when it comes to asset purchases. Salman Ahmed, global head of Macro at Fidelity International, stated that "In currencies it's the relative game that matters," and that "You can argue that the ECB has been very aggressive in its policy, but has it been more aggressive than others? If the ECB wants to get the Euro down, they will have to outgun the Fed – there is no other way."