At the start of Q3 as the global economy began to emerge from the self-induced coma of lockdown a clear consensus view emerged, that the EUR was at the start of a period of structural appreciation, and the USD structural decline. Much of this consensus was drawn from the extrapolation of three core factors: i) economic outperformance, ii) better virus control and, iii) relative size and historic structural significance of the European Recovery Fund (in particular, the fact that the fund itself drew, for the first time from a mutually liable debt obligation at the EU level). While many admitted that the “ambitious, temporary and targeted” Recovery Fund fell far short of a European ‘Hamiltonian moment’ (though it has likely set an historic precedent for mutual liability in acute economic distress), it was deemed enough to warrant confident forecasts of 1.25 and above for EURUSD.

As we move into Q4, it is clear that the pace of economic ‘reopening’ recovery in Europe was flattered (for want of a more appropriate description) by the pace of the shutdown decline, and thus the next phase of the global economic recovery will highlight not just the higher natural or potential growth rate in the US, but also the pre-existing conditions that weighed on the eurozone economy prior to the onset of the crisis. Furthermore, if, as we expect, the covid crisis brings about an accelerated transition towards the acceptance, use and development of technology based solutions then this growth differential in favour of the US only likely grows. If we also add in that the fact that the European Recovery Fund now looks too little, too late (without factoring in the current disputes about its ratification), and a time-limited (Nov 4th?) delay to a fourth US stimulus, not to mention recent covid-19 trends, and perhaps it is a surprise that commentators have not changed their minds about the ultimate trajectory of EURUSD.

However, despite the clear change in trend of the three factors discussed above there is likely a more compelling reason to anticipate EUR underperformance going forward, inflation. While distortions to both demand and supply in the acute stage of the covid crisis likely saw prices (outside of some household essentials) decline, it is the most recent collapse in inflation in the eurozone that is the most troubling. While the Fed have made it clear that they will push for fiscal policy as the primary means of economic support going forward, the ECB are likely to have to rely on further QE to flatten the curve in an attempt to encourage investment, growth and ultimately price stability.

These relative trends are only likely to exacerbate the inflation differential between the US and eurozone. Lower risk-free rates, lower growth and a lower inflation trajectory are very weak arguments for a higher currency in our view.

As the global economy reopened, there was a rising tide that lifted all boats. The eurozone economy may even have had a faster ‘rise’ but only due to the fact that it sank further to begin with. The next stage of the global economic recovery is likely to be harder sailing, and the EUR hull has more holes to fill – at least relative to the faster, more technologically advanced US boat!