The euro is having a renaissance.
Investors waking up from a deep sleep since the start of the year would have a job recognising the shared currency. When 2016 ended, the single currency was riddled with political risk, held back by low inflation and seemingly endless quantitative easing and hobbled by stunted eurozone growth. Several analysts predicted parity with the dollar was only a matter of time.
Look at it now. The euro has hit such a purple patch that it is now becoming hard to envisage what could derail its rapid progress.
The market had been reappraising the euro for a number of weeks, but largely sat on their hands, preferring the lure of a Trumpflation-fuelled dollar. In mid-April, the euro was worth not much more than $1.05.
That reappraisal is now complete. Trumpflation is dead, long live the euro. As Morgan Stanley analysts say, the market is undergoing a “pivot to Europe”.
In six out of the last seven trading days, the euro has climbed, taking it up 2.9 per cent in the period and past $1.12. In the process, it has become the best performing G10 currency this year. It is now 7 per cent higher against the bedraggled dollar in 2017 and trading around its highest level in six months.
Numerous reasons explain the euro’s newfound strength.
The latest came on Monday after German chancellor Angela Merkel described the euro as “too weak”. Investors pushed the euro half a per cent higher, presuming that Germany, which has long been the main beneficiary of a cheap euro, was signalling its willingness to rebalance Europe’s growth from core to peripheral countries.
However, the main catalyst for the euro’s recovery is Emmanuel Macron. His ascension to the French presidency has turned the spotlight away from eurozone political risk and shone it on eurozone inflation, up at just below 2 per cent, and an economy growing at a healthy click of 0.5 per cent in the first quarter.
“Economic data has been encouraging. With no immediate political risk on the horizon, this has allowed international investors to focus on European data for once,” says Ugo Lancioni, currency portfolio manager at Neuberger Berman.
For investors who once harnessed so many doubts about the euro, now they ask themselves – “what’s not to like?” This about-turn in sentiment is reflected in Chicago Mercantile Exchange positioning data which shows net euro longs at their highest in three years.
Meanwhile, new capital in European stock funds is at a record high, as is the eurozone capital account surplus, while the European Central Bank will next month issue changes in forward guidance, so adding to already heightened expectations of tapering.
Against this favourable backdrop, the euro hardly needs the assistance of the dollar to accelerate. Yet down goes the greenback for reasons of its own making, or rather those of President Trump – his domestic problems are weakening the market’s faith in his ability to deliver tax cuts and infrastructure spending and deregulation.
And this, at a time when euro break-up risk premium is disappearing, says Alberto Gallo, macro strategist at Alegbris Investors, “The paradox,” he says, “is that we may have shifted political risk from Europe to the US.”
Currency strength may symbolise a vote of investor confidence in the euro, but not for the first time it also awakens worries about the potential negative impact on the region’s exporters. Rodrigo Catril, currency strategist at National Australia Bank, says: “The rapid rise in the currency is now getting to a point where the ECB is likely to become uncomfortable.” The ECB is engaged in efforts to revive inflation, “but a strong currency could potentially undermine these efforts”.
Such talk is premature, says Jane Foley, forex strategist at Rabobank, arguing that neither the pace of the euro’s rise, nor its level, are unduly alarming. Indeed, the OECD calculates fair value for the euro on a purchasing power parity model at $1.25.
On that basis, says Ms Foley, “the euro is undervalued, the dollar is overvalued. So from that point of view, the euro is still relatively soft.”
For that reason, Algebris is forecasting $1.15 to $1.20 by the end of 2017. “You have to be positive on Europe,” he says. “The question everyone asks is: ‘is the reflation dead?’ In short, no. It’s moving to Europe.”
Investors have several benchmarks against which to measure the euro’s progress. Most immediately is whether the EU clinches a deal on disbursing Greek debt. Next month, the market will get a better idea of Mr Macron’s ability to deliver his policy agenda when National Assembly elections take place.
At the end of the summer comes the German presidential election which could clear the way for eurozone fiscal stimulus, along with the ECB’s September meeting and the prospect of the first clear signs of tapering.
Longer term, the market will focus on whether a Merkel-Macron axis can strengthen European institutions, create closer co-operation in areas such as capital markets and overcome disaffection towards the EU still prominent in parts of Europe, especially Italy.
These are issues for later. Right now, the euro is in the vanguard of the currency market. Forex traders say they have seen it all before, yet few of them could have predicted such a remarkable turnround so quickly.