EURGBP Trade Idea July 2020

This week’s forecast on EURGBP we’re bringing you a fundamental analysis rundown of the popularly traded forex pair. The whole COVID-19 pandemic is causing lots of trouble around the world with more countries starting to impose secondary lockdowns. This is going to be a massive blow to major exporters, so we’ll dive into the data but also the political themes arising.

The “macro currency strength meter” is our first step in this forecast and analysis. The economic data based on the currency strength meter is showing potential signs of weakness for the Euro but also some strength coming in for the GBP. One of the big factors in this potential push UK’s resurgence from lockdowns starting 4th July. This will allow businesses and employment to continue as normal but also reduce the need for sovereign stimulus. The euro area has seen weakness throughout this year with Italy and Spain being majorly hit areas of the Virus.

Here’s our summary of the data on how we’re scored it. We’re looking fairly confident in a downwards potential move but there are some data points that would give me a lot more confidence in the forex pair heading to a downwards trend. We’ll discuss them later on in the post so make sure to make some notes!

The EURGBP forecast on GDP differentials is looking fairly interesting. Mainly because the blue line (differentials) have been weakening whereas the EURGBP in range starting to hit levels of resistance. The overall data shows a -1.3% GDP differential between EUR and GBP which means the Euro area has been contracting 1.3% more than the UK. If this trend was to continue, we may see a potential downside move in EURGBP with all factors being neutral.

If you look closely at the data points between 2010 and 2014 you can see the blue line slump below the 0% white line. This was followed by EURGBP depreciating in value, if history repeats itself, we may be in for a great trading opportunity.

Following our trade analysis on EURGBP we want to determine what are the main factors impacting the exchange rate through trade. What we’ve found is that Cars, Car parts, Crude and refined petroleum are factors within the export and imports which we need to look at. That’s why below we’ve chosen to analyse some people’s favourite car brands BMW.

Remember to watch our free fundamental trading webinar if you haven’t already gone through it. We go over the main advantages of trading using fundamentals and why it’s important in your analysis if you want an edge over other traders.

The BMW returns against the EURGBP exchange rate show some interesting correlative signs. Both assets have been rising since 2004 at a similar rate. The correlation statistics showed a 27% positive correlation between the assets which we believe is useful to add towards the overall fundamental analysis. Overall, there’s been a -1.71% drop in value of BMW which equates to a -2 on our currency strength scoring. However, since the trade analysis is the analysis of multiple factors, we need to check all the main assets before we come to a solid conclusion on shorting or longing the pair.

Another major European car exporter is Volkswagen. Previous analysis has shown that because of their market dominance in car manufacturing it’s crucial to include them in the EUR fundamental analysis and forecasts. What we have in the data above is both the blue and orange lines growing at similar rates. Specifically, they have a 53% positive correlation. Therefore, since VW has shown a negative return of 1.64%, we’ve also scored this at -2 in our fundamental currency strength score.

You can probably see an underlying theme here regarding the car industry. Since many countries are in Lockdown, no one has a need to drive around. Since there’s no car show rooms open cars can’t be sold. This directly impacts the manufacturing companies which is why they’re probably delighted lockdowns are being eased across the world. In their points of view, it may help stimulate demand and restructure supply chains.

Now we’re onto a commodity which the UK actually still exports which is Oil. More specifically BRENT OIL which is located north of the UK near Norway. This is a different type of oil compared to the main oil index WTI. The correlation between the two assets show a 38% positive correlation but the recent returns have been negligible at 0.5%. That’s why we’ve scored it at a neutral score 0.

Now we move onto the interest rate differentials one of the most important factors when analyzing forex pairs. The EURGBP interest rate differentials have been on the rise since the 2000s as it seems that the EURO seems to be safer than the GBP. During the 2007 crisis you can see that interest rates plummeted in the UK but for Europe they dropped slowly. This saw the EURGBP skyrocket during that period. Recent data in the blue line has shown that because the BoE has cut rates to 0.1% the interest rate differentials have been rising again which are concerning signals for a short idea.

Ideally, we would want the EUR interest rates to be weaker than UK which they currently are sitting at 0%. However, the gap has been tightening and, in the future, it would be no surprise if interest rates in the UK dropped to 0%. This would flat line the interest rate differentials. However, currently they are rising slightly. Overall, the short idea looks promising, but the interest rate indicator does not. We’ve scored it a +3 on our scorecard because it’s rising but it’s still a negative differential which means the euro should still be weaker.

Our final data analysis is to see what the stock index is doing and the wealth of Europeans as a whole. As you can see from the data there’s been a 19% drop in value in the EUROSTOXX 50 which creates a 4 score on our fundamental currency strength. The reason it’s a +4 is because of the inverse relationship which I’m going to point out below.

Overall, the index is inversely correlated to the EURGBP exchange rate by 73%! Which means if the index was to continue to go lower it might not be a great idea to short, but if the index was to increase in value it could mean a short bias is on the way.

As you can see from the full analysis, we’ve got an overall relative score of +6. This does not coincide with our currency strength meter reading which means the idea could still be too early. The main factors we’re looking to see change and ones which can tip the scales for a short is the stock market returns and interest rate differentials.

If interest rates in the EU were to fall to negative interest rates this would be a huge blow on the EUR currency and would create a negative score on our currency strength system. That’s the same with the Euro stoxx 50. Since there’s an inverse relationship we’d like to see an increase in gains for EURO STOXX 50 but with the COVID-19 pandemic this is very unlikely to happen so we will need to wait for these factors to line up in favour of a short before pulling the trigger.

Looking over the COT indicator we can see that the hedge funds are the pink line and they’re the participants we want to be following. If you’ve read our previous analysis posts, we want to be following where they trade in the market and we have a simple way to identify this.

Rule: when the pink line is above 0 hedge funds are longing the asset and when it’s below 0 they are shorting the asset.

It’s really that simple. So, based on that we can see that hedge funds are shorting both the Euro and the GBP. If we want to short EURGBP ideally, we want the hedge funds to go from a negative score to a positive score. This would mean hedge funds are longing the GBP which fits with the currency strength meter.

On a technical basis the EURGBP exchange rate has hit strong weekly resistance point at 0.93. This is very likely to hold due to selling pressure seen in September 2019. If the same pressure occurs again which is likely we may see the exchange rate down trend for a long period of time. However, again due to fundamentals not being ready just yet as we’re still waiting on those Interest rate differentials and stock market performance numbers to change, we still need to be patient traders and just add this to our watch list.

Remember, if you don’t know how to watch out for those numbers make sure to watch our free fundamental webinar to understand how. We’ll introduce you to the Logikfx academy and see if it’s a fit for you!