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Why EUR/USD is on a collision course to parity

The EU’s standoff with Italy is only going to send EUR/USD in one direction, says InterTrader’s Steve Ruffley.

Euro traders expect increasing volatility in coming weeks on the deepening rift between the EU and Italy.

The European Commission has just taken the unprecedented step of rejecting Italy’s budget.

Italy’s controversial spending plans, which could swell the country’s already bulging budget deficit and debt, break EU rules and the bloc is demanding more fiscal discipline from the country’s populist, anti-establishment coalition government.

The EU has told Rome it must do better, and to go and revise its spending plans. But Italian Prime Minister Giuseppe Conte isn’t blinking. He’s said there’s no ‘Plan B’ for his government’s 2019 fiscal programme.

Where does all this leave the euro? Under more pressure. Italy already has the highest debt ratio in the eurozone after Greece, and its plans have unsettled investors, sending its bond yields to a five-year high last week. Combine this with recent poor data, such as the unexpectedly sharp decline in the composite PMI in October, and more dovish comments from European Central Bank President Mario Draghi at October’s policy meeting, and EUR/USD has hit its lowest level since August 17 at 1.1370.

InterTrader’s Chief Market Strategist can’t see an end to the selling pressure on the single currency.

‘I have long said sell the euro high,’ he says. ‘Although the euro has been on a fairly bullish run longer term, the intraday highs have always been fair game to sell into.’

Existential risks

He believes the euro’s problems go beyond Italy’s debt crisis, a bullish dollar or an ultra-dovish ECB. The single-currency bloc is facing a deeper existential crisis, meaning the euro’s long-term trajectory points only one way – down.

‘The EU is still failing to fix a divided Europe,’ he adds. ‘Draghi is much more concerned with the reputation of the ECB rather than the lives of the people in the EU.’

The EU’s problem, says Ruffley, is that it is battling many fronts, maybe more than the UK, and the situation in Italy is just highlighting the unrest in the bloc.

‘The EU has had lots of issues. Greece, migration, the German power industries, the Volkswagen and Deutsche Bank scandals and now Italy. The EU is far from united and this is why the euro is a sell. And of course there’s Brexit, with the world wondering who will win there. The UK or the EU? The easy answer to that is no one.’

The ECB’s stubbornness on rates is also an issue. ‘The EU has endured the same financial problems as the US and the UK, but unlike them it still refuses to stop quantitative easing and address rates,’ says Ruffley. ‘The QE balance sheet is far greater than that of the US, and ECB rates have been lower, even negative, for longer.’

But while the US looks to be heading back to real-term growth of 4%+, the EU may struggle to hold 2% or even drop lower.

‘The problem here is the US has room to manoeuvre. It can hold rates or even (unlikely) cut them. The EU cannot. Its next move has to be up. This will mean the euro goes up. This means the powerhouse Germany’s exports get more expensive, and the EU’s debt gets more expensive.

‘How do you pay for all this with little to no growth? There will be major attention paid to the EU when rates go up. Not if, but when. This will have a huge effect on the euro and in turn the ability of its member states to grow and pay down debt.’

The technicals

The euro has rejected all the key Fibonacci levels 38.2%: 1.25983, the key 50%: 1.21617 and the 61.8%: 1.17319 (see the chart below) so the full Fibonacci retracement should hit below 1.40000 and head for parity, according to Ruffley.

‘While the US Fed keeps raising rates and the ECB says no hike until late 2019, I see no reason to buy the euro over the US dollar or over the pound.’

EUR/USD monthly chart

Click to expand image

For more information and trading education visit InterTrader

The content of this article is the personal opinion of the author and not InterTrader. You should under no circumstances consider the information and comments provided as an offer or solicitation to invest. This is not investment advice. The information provided is believed to be accurate at the date the information is produced.

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