After EU stimulus delay, euro sets sights on flash PMIs as rally falters – Forex News Preview

Raffi Boyadjian, XM Investment Research Desk

Eurozone PMIs bounced back strongly in May, fuelling hopes of economic recovery in the world’s largest trading block. But with EU solidarity once again being tested as leaders are split on a virus rescue plan, all eyes will be on the preliminary PMI indicators for June due on Tuesday (08:00 GMT) for signs that the recovery remains on track. The data could set the euro’s next direction as the currency consolidates after coming close to fully retracing its March fall.

EU recovery fund runs into trouble

There can be no doubt that the COVID-19 pandemic caused economic devastation across Europe as the rapid spread of the virus forced much of the continent to go into lockdown. National governments have done their part in providing fiscal assistance and the European Central Bank, while not as aggressive as the US Federal Reserve, has pumped trillions of euros either directly or indirectly into the Eurozone economy. Where there’s been a shortcoming is having a fiscal response on a European Union level.

Hopes had been running high since late May that a Franco-German proposal for a €500 billion fund (to be disbursed in grants) is gaining momentum. But an expected agreement in June is now out of the question as frugal Northern European countries refuse to drop their objection to the bulk of the fund being comprised of handouts instead of loans. Senior EU figures are now looking at July as a more realistic timetable.

A large relief package consisting mainly of grants is seen as a crucial component of a recovery plan given how heavily indebted Eurozone economies are, particularly in the periphery. The ECB is struggling to keep periphery yield spreads from widening too significantly and a not-so-generous EU aid package could exacerbate the problem if investors were to downgrade their outlook on the Eurozone economy. A jump in periphery bond yields from reduced investor confidence could cause great pain for countries like Italy and Spain as it would come at a time when they need to borrow more to pay for their fiscal stimulus.

Lockdown easings likely boosted growth in June

In the absence of an EU rescue fund, all hopes rest on the gradual lifting of the lockdowns to boost growth in virus-stricken member states. The further relaxation of lockdown restrictions is expected to have led to another jump in economic activity in June. After rebounding to 31.9 in May, the Eurozone composite PMI by IHS Markit is anticipated to have picked up to 40.5 in June.

Looking at the sector breakdown, the flash manufacturing print is expected at 43.4, while the services PMI is forecast at 40.0. Although both would represent a decent increase from May, they remain below the 50 level that separates expansion from contraction. Hence, markets will be eager to see positive surprises on the scale observed in the United States from recent data on jobs and retail sales for signs that the European recovery is getting onto a stronger footing.

Can upside surprise in PMIs revive euro’s rally?

Should the PMI numbers fail to reassure investors about the strength of the Eurozone recovery, the euro could stay skewed to the downside. Additional declines could push euro/dollar towards the 61.8% Fibonacci retracement of the March slide at 1.1165. A breach of this support would put sellers within range of the 50% Fibonacci at 1.1064.

However, if the data outstrip the forecasts, the euro could receive a shot in the arm, putting the $1.13 level back within reach. The single currency has been consolidating after the latest upward wave peaked at $1.1422 earlier in June. Barring any dollar weakness, a deal on an EU stimulus and improving economic indicators are what will determine whether the euro is able stretch its rally past the $1.1422 top.