Euro May Rise on ESM, Crude Oil Selloff Deepens on OPEC Price War


  • Euro may rise if EU finance ministers choose to use market-stabilizing ESM policies
  • Crude oil prices continue to suffer from OPEC price war and coronavirus outbreak
  • USD/ZAR reaches new high, South Africa credit downgrade sends chilling message

Euro Eyes Eurozone Finance Minister Meeting: ESM in Focus

The Euro may rise following a meeting between Eurozone finance ministers on Monday where they are expected to discuss the possible use of the Emergency Stability Mechanism (ESM). The European-based agency was developed following the Eurozone debt crisis in 2012 as the shock from the 2008 financial meltdown asymmetrically hit the regional economy and pushed the Euro to the precipice of collapse.

The fund has a little over 400 billion euros at its disposable and includes a number different levers policymakers can use to stabilize financial markets and restore confidence. Some of these include purchasing sovereign debt in order to help distressed member states get access to credit markets. However, seeing that interest rates remain low despite the considerably darker outlook, officials may advocate to use other policies.

Greek, Portuguese, Spanish, Italian Sovereign Bond Yields – Daily Chart

Greek government bond chart created using TradingView

While the argument can be made that using some tools of the ESM could help restore market confidence, others worry that it may have the reverse effect. In other words, investors would look at Brussels using ESM tools of the ESM and worry that circumstances are so bad that the situation warrants such a drastic response. This may then undermine confidence and catalyze a Euro selloff.

Policymakers are also concerned that using the ESM at this point may be premature considering that comprehensive data regarding the impact of the coronavirus has still yet to be revealed. Some officials argue that it might be better to keep a proverbial bullet in the chamber so if a second wave of risk aversion disrupts economic and financial activity, policymakers can inject markets with another shot of liquidity.

Some of the measures the agency could implement include bank recapitalization which officials define as:

“Strengthening the capital position of a bank through capital injections, for instance by acquiring common shares. Often accompanied by additional measures, such as restructuring, raising capital privately, the sale of assets, or segregating impaired assets into an asset management agency (‘bad bank’).The ESM can provide financial assistance for the recapitalization of banks in three ways: (i) via a general loan to an ESM Member in support of a macroeconomic adjustment program; (ii) via a loan to an ESM Member for the dedicated purpose of bank recapitalization (indirect bank recapitalization); and (iii) via the ESM direct recapitalization instrument” – ESM.

Policymakers would also have to address the issue of member states exercising greater fiscal autonomy in light of the unprecedented crisis. However, the circumstantial urgency of the present situation will have to be reconciled with the potential crises it may breed in the years to come. Some officials have considered an emergency suspension of budget deficit laws and austerity measures tied to ESM loans.

Crude Oil Price Outlook Bearish as OPEC Price War Rages and Coronavirus Spreads

Crude oil prices are being assaulted on all fronts as the coronavirus pushes the global economy to the precipice of a recession while the Saudi Arabia-Russia price war is supplying more oil than the world demands. Like a bitter couple, Moscow and Riyadh are not on speaking terms after the former refused to implement additional production cuts at the most recent OPEC meeting in Vienna.

Total Confirmed Coronavirus Cases, Crude Oil Prices – Daily Chart

Chart showing crude oil

Crude oil chart created using TradingView

On April 1, the oil cartel – and other non-member producers constituting the so-called “OPEC+” group – will begin pumping oil at will following the disagreement on additional production cuts. Algeria – which currents holds the Presidency of OPEC – is calling for a meeting of the cartel’s Economic Commission Board “to be held no later than April 10 to discuss current oil market conditions”.

However, the price war between Russia and Saudi Arabia is also destabilizing the US energy sector. As a push towards achieving “energy dominance”, the highly-leveraged shale industry borrowed trillions of dollars to expand its operations but is now coming under pressure to service its debt. Relative to major oil giants, these smaller firms’ costs of production are significantly higher than their major counterparts.

Amid mounting domestic pressure, US President Donald Trump said he would consider intervening in the dispute between Riyadh and Moscow soon. Some US Senators have become so enraged by the plunge in oil prices that they have called upon the White House to present Saudi Arabia with an ultimatum: reverse your output decision or face “consequences”. These include sanctions and tariffs.

South African Credit Downgrade May be Canary in the Coalmine

Early on Monday, USD/ZAR registered its strongest exchange rate on record after Moody’s downgraded South Africa’s sovereign credit rating to “junk” status with a negative outlook. A statement from the rating agency goliath said: “The key driver behind the rating downgrade…is the continuing deterioration in fiscal strength and structurally vert weak growth”.

South Africa Government Bond Yields: 10Y, 20Y, 30Y,USD/ZAR – Daily Chart

Chart showing USD/ZAR

USD/ZAR chart created using TradingView

However, this downgrade may be the canary in the coalmine for other emerging market economies that may spread to their OECD counterparts. Last week, Fitch Ratings cut the UK look to AA- with a negative outlook from AA. While this is clearly not as severe as junk status, it may very well be the beginning of a broader credit downgrade across a wider range of countries.

This may create another shock to already-shaken credit markets that are still fragile and vulnerable as the impact of the coronavirus continues to be felt. In this environment, risk-oriented assets like AUD, NZD and emerging market FX may come under pressure while anti-risk hedges like the US Dollar and Japanese Yen may rise.

This dynamic may be amplified if the familiar but unwelcome fear of a contagion default from sovereign emerging market debt spreads into OECD countries. Frontier economies that issued dollar-denominated debt may come under additional pressure if their local currency undergoes a market-wide selloff while the Greenback strengthens across the market.


— Written by Dimitri Zabelin, Currency Analyst for

To contact Dimitri, use the comments section below or @ZabelinDimitrion Twitter

Be the first to comment

Leave a Reply

Your email address will not be published.