EURUSD Rise: What Happened to Safe Haven Flows?

EURUSD Rise: What Happened to Safe Haven Flows?
With all the markets getting riled up over the past week or so, it’s been interesting to note that the EURUSD rise has continued. From a geopolitical perspective, the Euro was initially conceived as an alternative reserve currency to the US dollar. After a couple years of talk of de-dollarization, is the greenback losing its safe haven status? Or is there something else at play here?

The main event that tipped the scales last week to cause the sea of red in the markets was the weakness in NFP data. But that was only the capstone to several other poor indicators that came out just before that – including in Europe. European PMIs showed that industry in the shared economy was still in contraction. Yet European yields held up a lot more than American ones.

Opportunities For Bigger Change

One of the major differences between the two economies is outlook. Right up until last week, it was largely expected that the EuroZone economy would remain practically stagnant this year. Yes, a “rebound” of sorts is forecast, above narrowly avoiding a technical recession last year. But the forecast was for growth of 1.0%. The US is expected to grow at twice that rate.

So, when the data was poor for both economies’ growth, it was already priced in for Europe. The bump up in unemployment in the US to 4.3% was a surprise, and triggered a recession warning after moving up 0.5% from the latest low. The EuroZone unemployment rate is already at 6.5%, and has been largely stable. Investors were already expecting poor economic growth in Europe, so there was no reason for a market adjustment. But they weren’t expecting that for the US.

The Higher the Rise…

The Fed has pushed rates up to 5.50% in order to combat inflation, which above the 4.25% the ECB did. And the ECB already cut once. What that means is if there is an economic downturn, the Fed has a lot more room to cut than the ECB. The Eurozone is facing relatively high inflation without much economic growth (stagflation). A slowdown in the economy, therefore, will have a minimal impact on inflation. Which means that the ECB would likely be slow to lower rates even if the economy were to decelerate.

In the case of the US, strong economic growth is linked with higher prices. A sudden deceleration in the economy would naturally come with a deceleration in CPI, which means the Fed could cut rates. In fact, the Fed might anticipate a slower economy and cut rates ahead of time to “soften the blow”. That’s after months of many analysts, economists and even bankers saying the Fed is waiting too long to cut. And, by keeping rates too restrictive, the economy might slow down as a consequence of monetary policy instead of something fundamentally wrong with the economy. In other words, the Fed might have to get more aggressive in its cuts to “catch up”.

Where Did the Safe Havens Go?

All of this culminated in the market suddenly pricing in a lot more easing from the Fed, and not much more from the ECB. As a result, US yields fell, while Euro yields sort of dipped. The end result being the dollar lost value, while the Euro stayed relatively unchanged, contributing to the ongoing EURUSD rise.

The drop in interest rate expectations was so large that it overcame safe haven flows. Meanwhile, investors were piling into the Swiss Franc and gold. Warren Buffet got out of his high-tech shares, building up cash. That’s a classic move ahead of an expected recession, when cash is king to buy up undervalued assets.

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