Investment News: the Euro stages a comeback

The single currency is flying. It has taken off since mid-May and jumped around 5% versus the Dollar since then. That was not expected. However, the bear case for the Dollar has been present since a very long time and only several new elements or developments have triggered the surge of the Euro.

Several factors in favor of the Euro

First, The US has been facing a big twin deficit for some time already, contrary to the EU. Second, the interest rate differential has fallen dramatically. Late 2018, the yield difference between the US and the German 2y government bond was around 3%, today it’s merely 1%. The difference, for many, no longer justifies taking the currency risk when buying US treasuries merely for the yield difference. Another strong factor was the attraction of big tech, which let’s be honest, is purely an American story. Massive amounts have gone into the FAANG stocks and have certainly helped the greenback. Today, with some sector rotation happening, some profit-taking is at hand. 

European stocks could observe massive inflows

Meanwhile in Europe, the big scare of a disintegrating Eurozone has been laid to rest, for now. The recovery fund story and yesterday’s clear message from the ECB tell another story, one that gives some hope for the old continent. Also, as everyone was terribly underweight of European stocks, the trend reversal seen today could gain momentum. Even if, international investors would simply decide to wipe out the underweight without going to an overweight, the amounts involved could be massive.

US Presidential Elections will have an impact on Europe’s attractiveness

Of course, the trigger for the sea change might not only have been a European story. The fact that COVID-19 has hit the US hard and still lingers in the US has possibly played a role. But most likely the turnaround in the polls regarding the presidential election are the real story. The death of George Floyd and the mass protests linked to it have given a boost to the election chances of Joe Biden. If Mr. Biden were win then US politics and especially economic policies could change dramatically. Higher corporate taxes and higher minimum wages would become very likely. What would that mean for corporate profits? The idea of lower profitability could also lead to some rotation out of the US to other places.

The Euro/Dollar PPP indicates a higher exchange rate

To be fair, other parameters to gauge the expensiveness of one currency versus another have also been favoring the Euro versus the Dollar. The purchasing power parity between both indicates that fair value is closer to 1.20-1.23 for the pair. But currencies only tend to mean revert to such levels in the long run, but eventually they do.

Perhaps this time, the move is for real. But before getting carried away, let’s not forget that Europe has always managed somehow to ditch investor confidence and that a stronger Euro does not help our export-oriented continent. Let’s see how this turns out.