Don’t doze off on the Euro

Doze off on the currency markets if you choose, but don’t come crying to us if you fall out of bed because the euro wakes you with a bang.

You can be forgiven for taking your eyes off EUR/CAD lately, with all the urgent drama in Q4. But the euro may jolt you awake—trading ranges are meant to be broken (see figure 1).

Figure 1: EUR vs. CAD

Street Consensus

Wall Street doesn’t publish many EUR versus CAD forecasts. But there is plenty on both currencies relative to the USD. Fortunately, if you know Street consensus on currency A vs. B and A vs. C, you can back into the strategists’ views of B vs. C.

Let’s do that.

Figure 2 shows the 15 most recently published forecasts for CAD and EUR vs. USD, with the arithmetic for EUR vs. CAD. Sentiment on this pair is mixed, with the median and average forecast coming in 2 cents off of the spot rate.

Figure 2: 2019 Street Consensus

Considerations

The Street may be torn, but that tends to happen after periods of sideways action. You’ll have to look at the politics to decide if you want to bear EUR risk this spring.

Start with Italy. The European Commission recently downgraded its forecast for the country’s 2019 GDP growth to 0.2%, mere inches above the red ink of Q3 and Q4.

Italy’s coalition government of protest party leftists and the anti-immigrant right are both attacking French president Emmanuel Macron. The left decries Macron’s “Jupiterian” regime for favouring the rich and being out of touch: a similar charge to the one that brought down former president Nicolas Sarkozy. The right is relentless too, hitting on Macron’s europhilic bona fides and his indifference to immigration grievances in first-port-of-entry countries.

Many Italians claim EU officialdom is taking a hard line on the Maastricht Treaty’s 3% budget deficit-to-GDP ratio limit when it comes to them—but that it is being more lenient with France.

After all, Macron was allowed to do an about-face after he miscalculated car-centric rural France’s rage against his 2018 gasoline tax. The gilets jaunes (yellow vest) protests were effective: Macron crawled back to the Élysée with his tax plan scrapped and an extra €11 billion in fiscal largesse thrown in for good measure.

To supporters of Italy’s Five Star Movement and The League parties (who, by the way, are going to be competing against each other in the May EU Parliament elections), France is getting off scot-free. The verbal attacks on Macron are incessant, and Jupiter is not happy about it. This is no minor spat; France just withdrew its ambassador to Rome for the first time since 1940.

Let’s not end without mentioning Germany’s place in all this.

Finance minister Olaf Scholz says the budget surpluses that have been standard in Germany since 2014 are ending this year, and that business-focused tax cuts are policy now.

The country could use the stimulus too, given its nasty 3.9% year-over-year fall in industrial production. And keep your eyes on credit default swaps of  Deutsche Bank and Commerzbank. The 5-year variety of the derivatives, which insure bondholders, are only back to November levels. If they stay ugly, we may see more tax cuts or spending from Berlin.

We have been saying that fiscal wars would be the next stage in this generation’s evolution from currency wars to trade wars.

The fiscal wars are Stage Three.

It appears to be playing out. The signs of expansionary fiscal policy for 2019 are there, if you care to look. From China’s recent tax cuts to India’s giveaway to rural farmers in an attempt to stave off the Gandhi political family, to the trio of Italy, France and Germany throwing goodies at the wall: if you’re still thinking about trade wars, then you’re stuck on last year’s story.

If you’re not convinced that Germany and its neighbours are open to fiscal stimulus, just remember that Trump is here until January 2021 at least. And just about every non-U.S. NATO member, save Greece of all countries, is failing to keep their end of the military spending bargain.

Tax cuts, pension goodies, defense boosts, whatever. It’s dandy for GDP growth, but tell it to the budget hawks, and tell it to the euro.

The currency is creeping bedside, just ready to disrupt what could have been a sound night’s sleep. We always say: the default view for most developed market equities is to hedge the currency to CAD, and only go “naked” that currency if you have a bull thesis on it. The trading range is going to be broken, one way or the other. Play it safe and get some decent sleep; hedge EUR to CAD.