- Decisive end to pandemic to boost EUR

- But second wave could light fire underneath EZ unity

- EUR currently hampered by Coronabond Failure

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The Euro exchange rate complex is looking firm as the end of April approaches, but the gains against the Dollar, Pound and other major currencies come too late to overturn the losses registered over the course of the past month.

The Euro is the laggard of the foreign exchange market for the past month, with the currency losing ground against all its G10 rivals, and we are told by one analyst that unless the covid-19 crisis evaporates there is a real prospect that this poor performance continues.

Indeed, analysis from UBS suggests that a slide to parity against the U.S. Dollar is possible in the event that another covid-19 outbreak and another round of lockdowns occur, as this would potentially widen the underlying political cracks in the Eurozone.

The Euro's underperformance during the course of April suggests there are specific issues at play for the Eurozone's single currency, as the currency is not simply following a 'risk on' / 'risk off' playbook like other peers.

The culprit for this potential underperformance is not hard to find: the Eurozone's inability to agree on a credible, unified funding approach to address the economic impact wrought by the coronacrisis.

In particular, it appears markets have sold the Euro on a failure by EU leaders to agree to fund a way out of the crisis by using a so-called coronabond - a bond issued by all EU states, but whose main beneficiaries will most likely be Italy, Spain and other hard-hit countries.

The rub for nations such as Germany and the Netherlands is that it is politically unpalatable to be seen to be funding statest such as Greece, Spain and Italy, as the below encounter between Dutch Prime Minister Mark Rutte and a worker attests.

A person to Rutte, PM of the Netherlands (@MinPres):

'Please! do not give the Italians and Spanish the money!'

Rutte: 'No, no, no'.

Then laughs. And a thumb up. pic.twitter.com/rpd0hnp0c4

— Pablo Pérez (@PabloPerezA) April 29, 2020The need for a new approach to funding came as Fitch announced an unscheduled downgrade to Italy’s rating late on Tuesday April 28, knocking it down a notch to BBB-, with a stable outlook.

This brings it in line with Moody’s but a notch below S&P.

In its review, Fitch said that they based the rating downgrade on Italy’s debt-to-GDP rising to 156% this year and remaining there over the medium term.

Typically a rating downgrade of this manner would imply the cost of borrowing for Italy should be, or will become, more expensive relative to its peers in the Eurozone.

In making a case for coronabonds, Fabio Panetta, the Italian European Central Bank executive board member, last week shone a light on a key flaw Eurozone in the Eurozone's architecture:

"The threat to the single market is clear: uneven fiscal support implies that a firm’s location, rather than its business model, will be the decisive factor in determining whether it survives this crisis.”

The coronabond is therefore not simply just an issue for the political future of the Eurozone, it also has significant micro economic implications as the Eurozone now risks seeing less competitive companies saved at the expense of more competitive companies simply due to geographical location.

"Panetta is probably right on this one. It is an issue if the access to Corona-bailouts is unevenly distributed across the Euro area," says Andreas Steno Larsen, Global FX/FI Strategist at Nordea Markets. "Well-driven businesses in Spain and Italy could be forced into bankruptcy due to the lack of funds available for Corona-bailouts as local authorities are running out of ammo. A less viable German competitor will on the other hand be backed by healthier public finances."

"Germany is probably never going to accept to pay everything for everyone, not least because cultural differences are simply too big for that to ever happen. That is the (fair) tyranny of the minority in the EUR. The problem is just how to make EUR function properly over time, if Germany doesn’t accept to pay? A gordian knot for the Germans," adds Larsen.

The implications for the Euro are clear: should the ructions over the coronabond be drawn out, the architecture of the Eurozone will increasingly become an issue for investors, which in turn poses potential downside for the currency.

But we would only expect the issue to continue to run should the coronacrisis extend.

The best route towards a stronger Euro is therefore for covid-19 to die back and economies reopen. This would soon see the issue of the coronabond swept under the carpet, like so many other headaches facing the Eurozone.

"We think a rapid return to at least a new normal by mid-year would be unreservedly positive for the Euro. In this scenario we would peg the euro at 1.20 by the year end," says Lefteris Farmakis, Strategist at UBS.

The Euro is forecast to rally even under a scenario where the exit from lockdown is more staggered and bumpy, "a more cautious and staggered removal of lockdowns, as seems likely, leaves our year-end forecasts intact – 1.15 for the Euro," says Farmakis.

A worst-case scenario - one that could severely impact the single-currency - would be an extension of the crisis, and its associated headaches for the Eurozone.

"By far the worst case for the single currency is a scenario in which the virus returns later in the year and restrictions are re-imposed. Here we could envisage trading parity by December as not only the safe-haven bid for dollars but also European unity risks reemerge," says Farmakis.