(Bloomberg View) -- The euro has had an impressive rally since mid-April, including a surge last week that took it to its highest level against the dollar since May 2016. The logical question now is whether the run is over, especially after the currency's softness this week in the face of some strong euro-zone economic data. Based on market fundamentals that have led analysts to rethink their pessimistic views and technicals that convey corporate hedging strategies, the euro is likely to strengthen further.
Fundamentals have been supportive for the euro since the beginning of 2017, when many analysts were calling for the currency to weaken to parity with the dollar. Currently, the euro-area inflation rate is 1.3 percent, but it was around 2 percent for a few months earlier this year. And growth in the euro zone looks strong, with the Ifo index, a leading indicator of overall German GDP, rising to an all-time high in June. Plus, the euro-zone manufacturing purchasing managers index, which is a critical leading indicator of growth, rose in June to the highest level since April 2011. The June reading also showed a 48th monthly consecutive expansion.
So, despite the schadenfreude shorts that U.S. traders have had on the euro, the euro-zone economy has now expanded for four full years, without a single monthly contraction. As a point of contrast, the last time the U.S. ISM manufacturing index contracted was less than a year ago, in August. And there have been contractions in six of the last 24 months for that indicator.
The euro-zone economy looks good, and the European Central Bank should be thinking about when it needs to become less accommodative -- and when it needs to raise policy rates. Unlike the Federal Reserve, the ECB hasn't even started yet. With ongoing ECB monthly net asset purchases of 60 billion euros and its policy rate levels (including a negative deposit facility rate), the ECB has a much longer way to go in terms of becoming full-on hawkish.
As for trading technicals, they have also been painting a bullish picture for the euro since the beginning of the year. In fact, there's been an unbroken trend of higher lows and higher highs since December 2016. Critical trading technicals, including the stochastic, relative strength index, on balance volume, and the critical 30-day and 100-day moving averages have been flashing an unmistakable buy signal to foreign-exchange markets.
The trend of higher lows also should reflect something important: inherently risk-averse corporate risk managers -- rather than traders -- may be sending the euro higher. After each missed opportunity to hedge at low prices, a pattern of consecutively higher lows has formed since January. Of course, in the current rising trend since January, the euro has fallen, but when it has fallen, it hasn't gotten back down to a previous low. And so, a pattern of higher lows has been formed.
This could reflect corporate hedging, as companies with risk exposures are more likely to follow a market when it rises because they are exposed to risks that they do not want to own. For example, delaying putting a hedge in place in a rising market in the hopes that the market falls does not offer big monetary rewards to someone in a corporate risk function, but it could present career risk. And so, risk managers may be more willing to chase a market with buy orders at increasingly higher levels, which can allow a support of higher lows to develop, driving the market even higher. This could certainly explain part of the euro trend of higher lows that we have seen so far this year.
Beyond bullish fundamentals and technicals, dollar bears are now almost extinct. This was not the case even a few months ago. As of the end of December, 16 out 91 forecasters surveyed by Bloomberg expected the euro to fall to dollar parity or lower this year, and it was a fairly reputable cast of characters, too. The most recent survey showed just two still see parity. That's a big change, and it reflects a major shift in the directional bias of the euro trade. The downside isn't the biggest risk to the euro anymore. Instead, it may be the upside.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Jason Schenker is president and founder at Prestige Economics LLC.
To contact the editor responsible for this story: Robert Burgess at bburgess@bloomberg.net.
For more columns from Bloomberg View, visit http://www.bloomberg.com/view.
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