Solid Jobs Report Slams the Euro – What is the State of European Affairs?

Tom Cleveland

Depending upon your trading tastes, the first Friday of every month can be either Nirvana or anathema, take your pick. Currency markets typically tighten up before the big Non-Farm Payroll release, courtesy of the U.S. DOL, then thrash about as analysts feverishly delve into the details to determine if there are any signals that will impact “Fed Think” or push the global economy to higher or lower levels. Major currency pairs connected to the USD freeze before the all-important 9:30 a.m. release moment, although a few outliers will attempt to guess beforehand and create a bit of turbulence.

This penultimate moment has come and gone, once again. 209,000 net new jobs was the verdict for July. Expectations had been 190,000. The Euro quickly descended from its high perch at one point of 1.191, down to the depths of nearly1.173. It finished the week at 1.175, a level of support that had been established one-week prior. Analysts were effusive in their praise of the strength revealed in the report: “This was a solid report in both the headline numbers and the internals. Literally the only negative was the decline in coal mining jobs (a Trump promise that is so far going nowhere).”

Why did the “EUR/USD” pair plummet? Bond yields tell the story: “The EUR/USD moved lower on Friday as the dollar gained traction following the stronger than expected U.S. payroll report.  Not only was the headline stronger than expected, but wages increased, pushing U.S. yields higher relative to German yields.  The solid strength in yields is buoying the greenback, reversing the recent strength in the Euro.” The focus now becomes will the Euro maintain 1.15 and above? If not, then watch out. Here is a chart:


If you had been fortunate enough to jump on the Euro train back in early April, you would be smiling from ear to ear, while counting your thousand-fold pips, one by one. Such trends as these are what traders look for and then leverage for all they are worth. Veteran traders will tell you that their trading books typically balance out, but they make their real money by limiting their losers and then profiting big time on a few healthy trends each month. Patience and discipline count in the long run.

The steepness of the Euro rise of late, however, would concern veteran traders, as well. In a word, that rate of slope increase is unsustainable. The bump up occurred when the Trump agenda ran into Congressional roadblocks. All major pairings with the U.S. Dollar benefited, but no one should hang their hat on political misgivings as a fundamental driver. The impact can be fleeting, almost illusory by nature. If you fall for the deception, then you may not be prepared for reality when it eventually takes hold. In other words, the Euro needed to retreat, and, if you visually look to a more favorable trending destination, then the 1.15 support level comes into immediate view.

Is there another major pairing that could deliver in the near term?

There has not been a pullback in the recent surge of the “EUR/GBP” currency pair. The slope line is asymptotic and impervious to jobs data in the United States. The EU economy has been showing signs of life, while the UK has been sluggish and, perhaps, mourning over what may come when Brexit negotiations hit full throttle. Whatever the reasons may be, the word on the street is that 1.05 is not an unrealistic target.

Forget the USD. European traders are now licking their chops at the prospects for a “EUR/GBP” duel in the sun. If you can find two currencies that are moving in different directions, based on their own unique fundamentals, then grab a position for that pairing and ride the new wave to come. The following chart, based on positioning from the week before, is fueling the newfound interest in this pairing:

BMO Capital

Are EU fundamentals as solid as the U.S. jobs report?

Sooner or later, the attention of the analyst community would, as expected, return to all things European. The sudden appreciation of the Euro has not gone unnoticed. It may have been hidden in the shadows of Trump trepidations and oil price cabal antics, but everyone is now focused on the European mainland and questioning whether the fundamentals support what has been a true technical rally. One new headline may read, “Euro Area Growth: Full Steam Ahead,” while another non-believer might pen the phrase, “Europe Rising?”, with added emphasis on the question mark.

Before we jump upon the Euro bandwagon, we might want to heed the missive from a think tank of economic professors in Amsterdam by the name of “Shareholders Unite”: “The structural design deficiencies in the Eurozone have been papered over by the cyclical tailwinds in the economy and balming ECB action. But at the first sight of headwinds, these will reassert themselves with a vengeance. Remedial action is already very difficult as it involves a leap forward in European integration for which there is no electorate. But things are even more complex as there are two very different narratives ruling the Eurozone.”

In the past, we have often heard that there are major structural weaknesses in the EU format, which must be addressed if the entire experiment is to prosper long term. The recent political threats from the populist right seem to have been thwarted for the time being, but these undercurrents could have easily led to a broad unraveling of the affairs of state. With an “exiting” mentality going by the wayside on the continent, this situation leaves the UK to twist slowly in the wind, one reason the “EUR/GBP” pair looks so inviting at the moment.

Favorable ballot box results may have only given EU officials a bit a breathing room. The major problem that has developed over the past decade still remains – there are two different narratives that persist related to lack of success of the union:

  • “The German view is that most of the peripheral countries lost competitiveness because they failed to implement structural reforms, the kind of which Germany itself implemented in the 2000s.”
  • “The view from the periphery is that these countries were overwhelmed by capital inflows as a result of the creation of the Euro (which eliminated the exchange rate risk in the periphery), and this led to a slow erosion in competitiveness, as it produced higher inflation in the periphery compared to the center, without the ability to correct this through devaluation of the currency.”

It can also be added that Germany benefited handsomely from the lower value of the Euro, since the combined currency’s value was a good 30% less that what the Deutsche Mark would have been otherwise. Trading profits that flowed into German coffers were never shared with other member states in the union. There was no mechanism to accomplish this feat, nor would German officials have ever approved of one, the essence of the conflicting view of the second narrative presented above.

The issue is one of competitiveness. Germany has plowed along, amassing a huge capital account, some 8.5% of GDP, which has literally sucked demand away from other member states. Germany continually points to “Hartz” labor reforms that were enacted to manage the domestic issues arising from unification efforts with East Germany. Critics claim the benefits have been overstated and that the true problem has been inflation in the periphery, while Germany and other core states have had little if any inflation to speak of. The following chart is emblematic of these continuing arguments:

Real Unit Labour Cost
Germans argue that their productivity exceeds the rest of the EU by large margins, but the other side of the argument is that Germany has benefited from near deflation, due to a Euro that disguised the true cost of its goods and services. While other member states adjusted by implementing onerous policies, Germany turned its eyes elsewhere. The “burden of adjustment”, as it has been described in the press, has fallen upon the shoulders of weaker member states, and Germany has sat idly by and done nothing to address the problem at hand. In other words, something has got to give in the future, if sustainability is truly the primary objective.

The new French President, Macron, has been a breath of fresh air and has gone out of his way to speak publicly of a renewal of the French/German partnership to drive prosperity throughout the EU. These words find welcoming support in Deutschland, but he also quickly notes that a bigger issue requires German cooperation: “Germany has benefited from the dysfunctional character of the Eurozone, from the weakness of other economies. This situation is not healthy because it is unsustainable.” Will Germany adjust its thinking or continue to pocket profits at the expense of others?

The European economy is showing signs of improvement

Second quarter GDP growth results for the EU were 2.1% on a year-over-year basis. Consumer sentiments have been high, and there is a general feeling that growth will eventually drive inflation to targeted levels. Mario Draghi and his buddies at the ECB are confused: “We see growth above trend and well distributed across the Euro area, but inflation dynamics remain more muted than one would expect on the basis of output gap estimates and historical patterns.” More analysis is required.

Unemployment fell from 9.5% to 9.1%, but there is still major slack in the labor pool, which means the economy has room to run. The Purchasing Managers’ Index (PMI) is also showing signs of robust growth, which, according the Chris Williamson, a local business economist, “puts the Eurozone economy on course for another strong quarter.” Time will tell.

Concluding Remarks

The Euro has been on a tear and shows no signs of letting up, but are these gains supported by true economic fundamentals or is the EU state of affairs wobbling upon a house of cards? The experts in Amsterdam share this opinion: “The present cyclical upturn, boosted by the ECB, a falling currency (until earlier this year), and falling energy prices has papered over some of the structural fault lines in the Eurozone, but these will re-exert themselves at the first sign of headwind.”

These sobering thoughts may curb your excitement over riches to come from the “EUR/USD” pairing, although many foresee a greener pasture over at the “EUR/GDP” address. Do you short or go along, and with which pairing? There are profits to be made, but let patience be your guide. Resist the temptation to pick a bottom or top, but jump upon the train once a true trend develops.

Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.

Tom Cleveland
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