This morning saw Germany’s Business Confidence index rise to all-time highs.
The Euro has hit one-year highs against the Dollar. Even as European interest rates are still negative, and the European Central Bank persists with QE. This is, of course, the point about the Eurozone. The ECB set interest rates for all countries within the Euro, not just Germany. Yes, Germany persistently runs surpluses, but hey, it’s propping up Greece now isn’t it, basically? That’s the deal of a monetary union. Oh but it’s not just an intra-Eurozone matter these days, now that DJT is in the White House. He hasn’t used the threat of calling anyone a Currency Manipulator yet – mostly because some of the key targets, such as China, are now allies required to fight a bigger enemy. But that won’t always be the case.
Hence Angela Merkel pops up yesterday with a nice little chat to school children – and ends up driving the Euro to the highs of the day. She responded to a question about trade with ‘The euro is too weak — that’s because of ECB policy — and so German products are cheap in relative terms. So they’re sold more’. If the Euro wants to rally on that, then that’s just a sign of market psychology. The gap higher in the Euro following the 1st round of the French election has never been filled. Ever since Macron successfully won the 2nd round, we have seen massive inflows into European equities:
Comparing the previous peak is instructive. That period of ECB QE was accompanied by a weaker Euro, as the inflows into those equities were hedged. That made sense – own the asset that’s rallying, but not the currency when it’s evidently being deliberately trashed. This time around, it really is different. Not only is there a massive underweight European equity position that’s turning around, but the currency has fewer detracting forces than ever before. You may still question the value of a currency whose structure is an imperfect union. But the lessons of the last few years have shown, as Merkel herself said, that the answer to Eurozone crises is “More Europe, Not Less”.
Now we have that German election to throw into the mix. The year began with a riot of headlines from across the German press, severely criticising the ECB’s policy. Bild screamed “Raise Rates Now” and SZ warned “Change Course Mr Draghi”. How will that translate in 4 months’ time when inflation, growth, confidence are all even higher? And 2 year German interest rates continue to be heavily mired in negative territory?
The pressure on the ECB to move away from their stimulus will be intense. Already there are calls from Merkel’s MPs that the next ECB President must be German. To be fair, Italy, France and the Netherlands have had a go so far in the life of the Euro – and Germany would be a sensible choice during a period in which the EU and the Eurozone will be under even more pressure to reform, post-Brexit.
So, we have a political backdrop that wants the ECB to change course…
We have improving European economic data…
We have portfolio flows going into European assets…
We have a central bank that’s starting to use the sacred “taper” word….
The fly in the ointment for a stronger Euro will be how the market interprets the inevitable heat and light of Brexit negotiations. Does the UK storming out of talks hurt UK or European assets more? Or does 100bn EUR, and other EU27 demands, look so unreasonable that Europe is penalised? Or is it considered a sideshow unless the European economy itself wobbles?
Whatever happens, the days of “the Euro is there to be trashed” are over.