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The euro crushed ALL its forex rivals in 2017, which is an impressive recovery after the Euro’s poor performance in 2016.

And looking at price action on the euro, we can see that the euro started steamrolling its forex rivals on April 24, which is after the first round of the French Presidential elections ended with Macron, who is viewed as the pro-EU and status quo candidate, having a lead versus his anti-EU rival, Le Pen of Front National.

Overlay of EUR Pairs: Daily Chart
Overlay of EUR Pairs: Daily Chart

Macron’s edge over Le Pen was interpreted as a sign that Macron will win in the second round of elections versus Le Pen. And the rest, as they say, is history.

As to why Macron’s victory was very good for the euro, recall that I noted in last year’s recap that two of the reasons why the euro had  a bad run in 2016 were the June Brexit referendum and Trump’s victory in November since those ignited fears that populist, right-leaning, Eurosceptic movements were on the rise.

And those, in turn, caused fears to flare up that anti-EU parties would win the 2017 elections in France and Germany which would destabilize the EU.

However, Macron won in the French elections even though there was a terrorist shooting in Paris and an attempted stabbing attack a few days before the elections, which should have given the anti-EU, anti-immigrant Le Pen a popularity boost.

Macron’s win was therefore taken as a sign that Eurosceptic movements were not a threat to the EU’s stability after all, which convinced large players to start a massive unwinding of euro shorts.

Source: COT Report from the CFTC
Source: COT Report from the CFTC

The euro’s rise later accelerated on most pairs when Draghi gave a speech on June 27 since Draghi dropped the earliest hint that monetary policy may change when he said that:

“[T]he central bank can accompany the recovery by adjusting the parameters of its policy instruments.”

After that, the euro got pushed higher when Draghi signaled during the July 20 ECB presser that monetary policy could change before the year ends.

However, the euro’s broad-based bullish run ended up becoming more mixed during the month of September, thanks to rumors that ECB officials were supposedly becoming worried with the euro’s strength, as well as disappointing news that German Chancellor Angela Merkel’s CDU/CSU won less seats during the September 24 German Federal elections and would need to form a coalition government.

Worse, the SPD, which captured the second largest number of seats in Parliament, made clear their intention to take the role of the opposition, which clouded the possibility of forming a coalition.

Worse still, the AfD, which is labeled as a far-right, anti-EU, and anti-immigrant party, rose from having no seats to having 94 seats, making them the third strongest party in Germany, further limiting Merkel’s options for coalition-building.

Dip demand was ever present on most EUR pairs, however, since the Euro Zone’s economy continued to meet or beat the ECB’s forecasts and ECB’s Draghi openly stated during the September ECB statement that “unless a risk that is not seen today materialises, we should be ready to give the bulk or to take the bulk of these decisions in October,” referring to the ECB’s change in monetary policy, particularly with regard to its QE program.

And when October finally rolled around, the euro’s price action became even more mixed rather than jumping higher. You see, the ECB announced during the October ECB statement that it will extend its QE program, but at a tapered pace of €30 billion per month. However, the ECB maintained its easing bias on its QE program while heavily hinting that interest rates won’t be rising anytime soon.

Moreover, fears with regard to Catalonia’s bid for independence came to a head on October, culminating in Catalonia’s declartion of independence from Spain the day after the ECB statement. And Spain responded by announcing that Catalonia’s bid for independence was illegal and dissolving the Catalan government, calling for fresh regional elections, and later issuing arrest warrants for some Catalan officials.

Even so, dip demand remained notable and some EUR pairs continued to tilt to the upside until the year came to an end since the Euro Zone economy continued to meet or beat the ECB’s forecasts.

In fact, the euro got a noticeable broad-based bullish boost starting on November 9 when the ECB’s latest economic bulletin presented an upbeat assessment and outlook on the Euro Zone economy.

Also, the European Commission’s (E.C.) released its Autumn 2017 Economic Forecast on that same date. And that showed that the E.C. upgraded its growth forecasts, with the 2017 forecast of +2.2% being the fastest rate of expansion in a decade. And while the E.C. downgraded its 2017 HICP forecasts a bit because of the stronger euro, the E.C. still upgraded its forecast for 2018 and then forecasted that inflation will further pick up the pace in 2019.

Another good piece of news that likely helped to keep the euro supported is Social Democratic Party of Germany (SPD) leader Martin Schulz’s conciliatory tone when it comes to forming a coalition with Merkel.

Looking Forward

Focus will likely be on German government coalition talks at the start of 2018 since the SPD has agreed to exploratory talks with Angela Merkel.

Talks are expected to start in January and there’s potential for drama (and volatility on EUR pairs) since SPD leader Schulz has been stressing that talks will be open and that he is ready to walk away if Merkel refuses to yield to some of SPD’s demands.

And while Catalonia has been pushed into the background because of German politics and the ECB’s forward guidance, there’s still some drama going on, so you may wanna keep an eye on developments there.

Speaking of the ECB, Draghi stressed quite heavily during the December ECB statement and presser that monetary policy won’t be budging anytime soon because the ECB isn’t convinced that the recent rise in inflation is sustainable.

To quote from Draghi himself:

“We say price pressures remain muted and have yet to show convincing signs on a sustained upward trend. So the conclusion is: an ample degree of monetary stimulus therefore remains necessary for underlying inflation pressures to continue to build up and support headline inflation developments over the medium term. So, no change all throughout.”

This could mean that the ECB will have less of a role in the euro’s price action in 2018. However, if economic indicators (especially HICP) continue to evolve within expectations or better, then that may stoke speculation that the ECB may make a move or at least switch to a more hawkish tone sooner or later.

And while Brexit talks didn’t really have an effect on the euro’s price action in 2017, it’s possible that they may have an impact in 2018. After all, the post-Brexit trade deal will also affect the E.U. More importantly, the E.U. is a net exporter to the U.K., so if talks crumble then that would also be bad news for the Euro Zone economy.

Bonus: CHF & EUR Reconnect

As you can see in the table below, the Swissy had a mixed performance in 2018, so it’s understandable if you think that the euro and the Swissy had conflicting price action.

However, if you’ve been following Pip Diddy’s weekly recaps and/or if you were able to read up on my old write-up titled What’s Up With The Swiss Franc Lately, then you probably know better.

And looking at the sample pairs below, we can see that the euro and the Swiss franc’s price action were very similar for the most part. But as marked below, the Swissy and the euro’s price action had a very noticeable divergence from late July to early August. And it’s this divergence that knocked the Swissy lower in the ranking table.

EUR/USD vs. USD/CHF (inverted, red): Daily Chart
EUR/NZD vs. NZD/CHF (inverted, red): Daily Chart
EUR/NZD vs. NZD/CHF (inverted, red): Daily Chart
EUR/GBP vs. GBP/CHF (inverted, red): Daily Chart
EUR/GBP vs. GBP/CHF (inverted, red): Daily Chart

So what caused the divergence? Well, nobody really knows for sure. But the most commonly cited reason is that the safe-haven trade on the Swissy is finally starting to unwind. And the COT report does show that commercial traders drastically reduced their long positions on CHF futures in July, so that theory does have legs to stand on.

Source: COT Report from the CFTC
Source: COT Report from the CFTC

Oh, and if you’re a newbie who’s wondering what the “safe-haven trade” on the Swissy is all about, that refers to the SNB’s unexpected decision to remove the “floor” on EUR/CHF way back on January 15, 2015, which caused the Swissy to appreciate tremendously.

Basically, that “safe-haven trade” refers to this, which is the reason why the euro and the Swissy decoupled in the first place:

EUR/CHF: Daily Chart
EUR/CHF: Daily Chart

Anyhow, unwinding by Swissy longs does make sense since EUR/CHF has been trending higher since the monster drop. That doesn’t stop the SNB from threatening that it will continue to remain active in the forex market to weaken the Swissy, however.

Still, it should be noted that the SNB did soften its views on the Swissy’s exchange rate when it changed its language from “significantly overvalued” to “remains highly valued” during the September SNB Statement. It should be pointed out, however, that the SNB’s change in language didn’t really have an impact on the Swissy price action.