- Global stock markets rise in wake of Fed cut

- Improved sentiment hampers Euro

- But too soon to call end to global rout

Image © European Central Bank

- GBP/EUR spot: 1.1539, +0.60%

- Bank transfer rates (indicative): 1.1235-1.1316

- FX specialist rates (indicative): 1.1380-1.1430 >> More information

A reversal in the Euro exchange rate complex - following days of gains - has allowed the British Pound to move back above €1.15.

The Euro's stellar run since global financial markets caught the coronavirus jitters has left the currency looking expensive in short-term timeframes, and a retracement of a portion of its gains was always likely.

The fundamental trigger to the Euro's pullback meanwhile appears to be the rally in global stock markets, to which the Euro is negatively correlated. In short, when markets are selling off the Euro tends to find support, when markets are rising the Euro fades back.

Research by HSBC shows that the Japanese Yen is the most likely to benefit from when markets are experiencing a risk-off episode, closely followed by the Euro and then the Swiss franc. "We believe that while one story or theme dominates financial markets, FX will remain beholden to the forces of Risk On – Risk Off," says Dominic Bunning, Senior FX Strategist at HSBC Plc.

This relationship is largely a result of the single-currency's status as a funding currency; Eurozone interest rates are at record lows and this allows investors to borrow cheaply in euros and then fund forays into higher-yielding global stocks. When investors sell their holdings, a sizeable demand for euros is triggered as capital is repatriated.

We are however currently witnessing a moment of 'risk on' trade as investors look to hoover up discounted stocks. Wall Street futures on the IG platform suggest the Dow Jones will open around 2.28% higher, the S&P 500 1.5% higher while the FTSE 100 is up 1.60% and Germany's DAX is 1.83% higher.

The Euro is down across the board in this environment: the Euro-to-Dollar exchange rate is down 0.43% at 1.1129 having been as high as 1.1213 on Tuesday while the Euro-to-Pound exchange rate is half a percent in the red at 0.8673, having been as high as 0.8744 on Tuesday. This gives a Pound-to-Euro exchange rate of 1.1528.

We have seen Sterling-Euro find some temporary support in the 1.1435 vicinity and wonder if this could become a temporary floor for the pair. We will however want to see successive days where the exchange rate closes above here before suggesting the Pound's decline against the Euro has faded.

Of course, in the current environment it appears that the performance of the Euro is what matters for the GBP/EUR pair, which is in turn dependent on the to-and-fro of global investor sentiment.

"Market sentiment certainly seems to have stabilised after a historic U.S. session which saw the role of monetary policy undermined as traders sold into an extraordinary bout of easing from the Fed. Powell was quick to acknowledge that the FOMC rate cut would do little to slow the spread of the coronavirus, yet he is unlikely to have predicted the market reaction. The U.S. economy is actually yet to feel a significant economic impact from this virus, and thus the decision to take such drastic action provided markets with a warning of exactly how big this threat is," says Joshua Mahony, Senior Market Analyst at IG.

While markets are up at the time of writing, there remains an overwhelming consensus that the global economy remains at risk of a significant slowdown, the full effect of which is yet unknown.

The global manufacturing supply chain which relies heavily on parts made in China is shuddering as any surplus inventories that might have existed are run down. The extended economic shutdown in China is ending, albeit slowly, and we would expect manufacturing to choke further as the Chinese economy slowly crawls back to life.

All the while, flight cancellations, a more cautious public and declining tourism rates are all likely to be felt in the services sector.

In short, it is too early to call the end of the market sell-off and the Euro's impressive appreciation of late is not yet necessarily over.

"The rate cut will not work on its own and new stimulus or quantitative easing will be needed to avert recession if possible," says John Mayer, an analyst at brokers SP Angel. "We expect to see more news of slowing production lines as manufacturers and assembly lines struggle to replace parts from China."