Euro Washout Exposes Structural Issues

Date: Mon, 21 February 2020

Author: By Business Times



 Euro was awaiting to shine this year but unfortunately has extended the worst start since 2015 as the coronavirus scare reveals vulnerabilities for larger market shocks. The shared currency has lost more than 3 per cent this year which forced banks to retract previous positive predictions with very little light at the end of the tunnel. Its collapse to the lowest level since 2017 has led hedge funds to add to short positions and options traders to support bearish bets.


The euro is confronted with economic shock by the virus outbreak and political risks from Germany to Ireland. Added pressures on the common currency are also unresolved Brexit risks and concerns of United States imposing import tariffs on European cars. The euro's fall this year brings a contest on the flaws on its structure.


"The big picture is that the euro area remains a sclerotic structural mess," James Athey, senior investment manager at Aberdeen Standard Investments, said. "It consists of divergent economies with a range of idiosyncratic structural issues, who all fudged convergence criteria, and are now trapped in an ill-fitting straight jacket of a monetary union without fiscal transfers."


Euro, began in 1999, is shared by 19 countries ranging from Germany to tiny Malta. After gaining on the greenback in its first decade, the euro saw the European debt crisis hurt its prospects of becoming a reserve currency to knock the US dollar off. The drop in euro sentiment has been evident at banks.


The bank lowered its fourth-quarter euro prediction to US$1.13 from US$1.16, following similar action at JPMorgan Chase & Co and RBC Capital Markets. Danske Bank A/S downsized its year-end projection down to US$1.08, from US$1.15. The currency traded at US$1.0861 in London. The forecast cuts released after Germany's economy stalled in end 2019.


Economic and Political uncertainty has intensified in Germany. Angela Merkel's 15-year tenure as chancellor is ending in a succession battle. Ireland's general election was dominated by Sinn Fein, from the radical left. Adding to the unease, fanning doubts that euro-area governments will heed the European Central Bank's (ECB) call for fiscal stimulus to take over from monetary policy to boost growth. This, spurred talk of further easing at ECB. Brexit remains a threat for the euro as for the pound.


While UK exits the European Union, failure to put a new trade deal by year-end would cause serious economic risks for both parties. The global gloom also burnished the appeal of haven assets including the US dollar and highlights a concentration of risks in area of Euro. That fuelled the euro's slide and powered a rally in the Swiss franc. Also, the dip of the Euro is faster than the US dollar's rise. The correlation between the pair and a Bloomberg index that tracks the greenback is weakening, a signal that the story is more one of euro weakness than US dollar strength.


The euro remains an asset that many are keen to borrow, but few want to own. Its popularity in funding carry trades whereby investors use loans in currencies with low interest rates to buy higher-yielding alternatives.


Willem Klijnstra, strategist at Legal & General Investment Management, points out that while the outlook has turned bleak, the sheer size of the drop creates an attractive valuation case for the euro, adding that it "will probably be enough for us to consider a long euro position against the dollar, despite the negative carry". While a weaker currency would be helpful in the long run, investor patience runs low after a series of downfalls for the euro.


"The only way to make it work long term is for many economies to undergo severe and draconian structural adjustments and internal devaluation. But the social economic and political cost of doing so is untenable," said Aberdeen Standard's Mr Athey, predicting near-term support for the euro to kick in at US$1.05. "But eventually it will go lower than that and through parity with the dollar."



Keyword:, Sterling House Trust, SHT