Explainer: Why is the Euro at risk?

The Euro is at risk due to a number of unanswered questions, such as what central banks will do next and when interest rates will be cut. PMI surveys have turned sharply lower in China and Europe, and the dollar has fallen out of favour as western central bank policy diverges with the Fed.

Traders are ahead of the curve, with EUR/USD trading with a weak tone on the back of a resurgent dollar. The trigger for another leg lower in EURUSD is likely to be fundamental: a stronger CPI reading in the US, which has the potential to lead a repricing of US interest rate risk, and weaker PMI surveys from Europe are prompting some to expect a slowdown in the Eurozone later this year. The latest Senior Loan Officer bank lending survey from the Federal Reserve for Q1 has shown that lending standards have tightened during the first quarter and since the collapse of SVB bank.

All eyes were on Monday’s loan data from the Federal Reserve, which included tighter standards and weaker demand for commercial business loans to large and medium enterprises. This bank lending survey shows that lending standards are tightening across commercial, residential and consumer lending sectors. Banks cited deteriorating credit quality, a reduction in risk tolerance and concerns about access to funding as some of the reasons why lending standards were likely to be tightened later this year.

Larger banks are also tightening access to consumer credit including credit cards and auto loans. Mid-sized banks also report concerns about their own capital positions in the aftermath of the collapse of SVB and other regional lenders in recent months.

The immediate market reaction to this survey is mixed, with stocks generally unaffected, but the S&P 500’s regional banking sub index has picked up a little and is currently trading up 0.3%. The reason for the improved performance in this banking sub index could be because the Fed’s lending survey has not told us anything we did not already know or expect, and there is nothing to panic about in this survey.

The Federal Reserve’s latest report on lending standards did not deliver the doom and gloom that some may have expected. The focus now shifts to the CPI data due later this week, which is expected to show headline prices remaining steady at 5%, with annual core inflation falling back a notch to 5.5% from 5.6%. The market is still pricing in 100 basis points of rate cuts between now and the end of January 2024, with some analysts scaling back their expectations for rate cuts this year.

If the market does re-price interest rate expectations, it could be bad news for risk sentiment as expectations of cuts to interest rates tend to boost stocks, while expectations of higher interest rates tend to weigh on equity prices. It could also cause havoc in the forex space.