In our previous take on the euro in late February, we wrote that the bullish case for the currency was looking increasingly challenging. At the time, euro speculators were spooked by slowing forward-looking economic indicators, while upcoming political events in Italy and Germany risked the future unity of the region. While our outlook remains mildly bullish, this comes with the significant caveat that there is only one compelling argument to go long the euro today. Looking at the currency’s recent trading history, positive momentum is waning while the outlook for growth continues to worsen. Turning to sentiment, while speculative positioning is no longer at a bullish extreme, it remains at elevated levels relative to recent history. In short, the bull case is wearing thin.

Eurozone economic growth now decelerating

Following many years of accelerating economic growth, the Eurozone is entering a period where growth is decelerating on a rate-of-change basis. In our previous take on Eurozone GDP growth, we showed that forward-looking indicators pointed to a significant slowdown in expectations for growth this year. Since that time, expectations have fallen even further while actual (i.e. “hard”) data is also pointing to a slowdown. This is shown below:

Eurozone manufacturing sentiment and industrial production (3-month moving average)

(Click on image to enlarge)

Source: Markit, Eurostat, MarketsNow

As can be seen above, Eurozone manufacturing PMIs peaked in January 2018 and have started decelerating. Looking at industrial production, year-over-year growth peaked in February and is now trending downwards. After peaking at 5.2%, annualized growth in industrial production came in at 2.9% in April. As the Eurozone’s manufacturing economy sputters, the outlook for the currency is falling accordingly.  

Price and volumes point to decreasing confidence

Turning to trading activity in the euro, bullish momentum is now waning. Looking at a chart of the euro futures contract traded on the CME, the currency peaked in early February. Since that time, it has made a series of lower-highs, failing to rise above the current ceiling of 1.25. Looking at volumes, trading volumes on down days have exceeded volumes on up days. The fact that the euro is strengthening on decelerating volumes is a classic sign that bulls are running out of conviction. This is illustrated below:

Price momentum now neutral, while volumes increasing on down days

(Click on image to enlarge)

Source: CME, TradingView, MarketsNow

While bullish momentum has provided a strong tailwind for the currency in recent history, the picture today suggests a much more neutral outlook. Unless the euro can strengthen above 1.25 on significantly higher volumes, the outlook for the currency is looking more neutral. If current trends continue, we expect to downgrade our medium-term outlook to neutral as well.  

Sentiment not extreme, but remains at elevated levels

The last major factor working against the euro today is speculator sentiment. Bullish sentiment is once again approaching levels seen earlier in the year, and positioning is elevated relative to historical averages. Looking at speculator net long positions as a proportion of total open interest, this ratio is approaching highs last seen in January (prior to the sell-off). Comparing speculator longs to total open interest, Euro speculators have not been this bullish on the currency since early 2013. This is illustrated below:

The speculator community remains firmly bullish

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Source: CFTC, MarketsNow

As can be seen above, the number of net long positions held by speculators has been flat since early 2018. However, the proportion of speculator longs relative to overall open interest is currently 22.4% (just below the last peak of 22.6% in January 2018). In short, buying euros remains a consensus long position in the investor community. Despite decelerating economic data, euro bulls have not (yet) lost faith in the currency.  

Euro’s sole driver remains monetary policy

All in all, the bull case for further euro strength is hanging by a thread. With economic growth decelerating, quantitative factors pointing to a more neutral outlook, and elevated positioning in the speculator community, monetary policy remains the sole driver behind the euro. In recent history, commentary from members of the Governing Council and the ECB’s minutes have contained conflicting messages. In some respects, this is by design as the ECB seeks to exit its quantitative easing program later this year while minimizing the euro’s appreciation (which in turn causes Eurozone inflation to weaken).

While expectations of future monetary policy tightening is one reason to buy the euro, there is a significant risk that the ECB reverses course if Eurozone data continues to worsen. As more and more factors work against the euro, the currency looks closer to a top than a bottom. As such, our view is that the euro is probably undergoing a topping process today.