FX Update: EU focus intensifies, risk sentiment rolling over

Please tune into today’s Saxo Market Call podcast, in which we discussed the drivers of negative crude oil prices, signs that risk sentiment is rolling over, and the intensifying focus on the existential EU .

In yesterday’s FX Update, I waxed rather big picture on the laundry list of potential issues that could sustain high FX volatility and even drive it back to the March highs. The most clear and present danger this week is the EU Council video summit coming up on Thursday, and the euro is rather offered ahead of that meeting as the market frets an unsatisfactory outcome for all parties and the tail risk of a collapse in talks and an immediate full tilt into a new existential EU crisis – one with far higher stakes this time around. Merkel was out yesterday talking up novel new bonds issued by the EU commission and backed by EU budget revenues and sent strong signals on the desirability of solidarity, but Reuters reported that participants in a CDU leadership conference said Merkel stated that mutual bonds are not a path forward for the EU.

Elsewhere, Spain’s deputy prime minister Calviño proposed a €1.5 trillion package of “grants” to member countries, not loans – that could be financed by perpetual debt issued by the EU and with allocation based on the magnitude of the fall in GDP, rather than the absolute size of the economy. It looks and quacks like a mutual bond although there may be enough wiggle room in the definition for Germany and the other anti-mutualization countries to avoid calling it that. Regardless, the stakes are high and we will look at the sense of political solidarity and signaling at this summit as much as the technicals of any eventual deal.

Below we have a look at EURJPY, our favourite instrument for measuring EU existential risks, or the lack thereof, feeding into the single currency.

Chart: EURJPY
EURJPY continues to be the preferred focus for any EU existential strains worsening from here. The base case scenario outlined by our Christopher Dembik could yet see the euro under further pressure here if the takeaway from this Thursday’s meeting is one of a nervous détente and a kicking of the can down the road. The worst case would be a dramatic Italian or joint Italian/Spanish “walkout” – or the video summit equivalent – on a failure to get on the same page. For EURJPY, below the 116.00 area there are no real chart points until down in the 110 area, with the lowest weekly close since the advent of the BoJ’s QQE near 111.10 from 2016.