Euro Risks Endangered Status on EU Squabbling in Time of Turmoil

(Bloomberg) --

The European Union’s failure to rally together against the pandemic has left the euro the least defended currency of the developed world, reigniting fears of a breakup of the bloc itself.

Since the mid-March peak of this year’s market turmoil, the euro is the worst-performing currency in advanced economies, trailing a recovery in peers that was sparked by joint fiscal-monetary stimulus in their respective economies. Money managers’ positions in the shared tender have seen a bearish shift, while strategists are fast losing their optimism for a rebound.

Europe’s inability to mount a long-term joint fiscal defense against the economic shock from the coronavirus starkly contrasts with trillions of dollars of stimulus unveiled by governments from the U.S. to Japan. While doubts about the euro project’s longevity are nothing new, this time even the European Commission has warned that the region’s north-south schism could threaten the union.

“It’s not just Covid -- I don’t think markets have taken any comfort from what it’s done to the European Union,” said Jonathan Pryor, head of corporate foreign exchange at Investec’s Treasury Risk Solutions. “That’s putting another question mark on the medium to long-term value of the euro.”

The euro has fallen more than 3% against the dollar this year to around $1.08. While a Bloomberg survey of analysts still points to a recovery to $1.12 by year-end, the consensus prediction has actually slumped from the $1.15 level that was in focus at the start of the year. Also, option traders are paying little heed to any calls for a rebound, positioning instead for more weakness.

Break-up Blues

Asset managers reduced bets on the euro’s advance while leveraged funds increased net short positions, according to latest data from the Commodity Futures Trading Commission.

The virus has been raging through Europe for months, but euro-area leaders still differ on how to jointly contribute to a recovery package for struggling economies such as Italy. While officials have endorsed a short-term 540 billion-euro ($586 billion) plan to support businesses and economies, they haven’t been able to agree on a longer-term recovery program.

All this has revived worries of the currency bloc’s future. An index measuring the probability of a country leaving the euro in the next 12 months recently surged to its highest in three years. The sentix Euro Break-up Index, which is based on a monthly survey of individual and institutional investors, climbed close to 15, the highest since early 2017.

The lack of a cohesive fiscal policy is one reason why analysts at Bank of America Securities have decided to stay bearish on the euro for the rest of 2020. They estimate that the average fiscal stimulus in the euro zone is the second lowest among Group-of-10 nations at about 2% of gross domestic product so far, compared with 9% in the U.S.

“Though euro-dollar is undervalued by about 10% according to our estimates, we see it weakening further in the rest of the year,” according to Athanasios Vamvakidis, the head of G-10 currency strategy at BofA. “We forecast euro-dollar at $1.02-$1.05, with risks to the downside.”

Even the European Central Bank’s monetary policy has come under scrutiny after German judges ruled that some aspects of the institution’s earlier bond-buying program aren’t backed by EU treaties and needed to be fixed. Worries that more such lawsuits could undermine the ECB’s latest Pandemic Emergency Purchase Programme (PEPP) have fueled unease in European markets.

“The coordinated fiscal and monetary stimulus provided by U.S. policy makers stands in sharp contrast to the slow response from European governments hamstrung by a lack of political unity,” said Edward Park, deputy chief investment officer at Brooks Macdonald Asset Management. “The U.S. response’s relative strength is likely to supercharge the eventual economic recovery which will support the dollar versus the euro.”

Not everyone expects a downfall of the euro. UBS Global Wealth Management’s house view is for it to strengthen from here to end the year at $1.15. The view is based on the prospect of a weaker dollar amid a gradual global economic recovery and concerns over rising U.S. government debt.

“The euro zone is clearly more complex,” said Rolf Ganter, head of European equities at UBS Wealth. “The U.K. -- just one country, you make one decision, the U.S. -- one country, one currency, one decision. The euro zone has many countries under one currency -- it’s not that easy, it’s unrealistic to bring all nations to one decision quickly.”

“It seems to take a crisis in Europe to get things done, and we are right now in a crisis,” he said. “You think obviously that is bad for the euro, but in the end it still exists.”

©2020 Bloomberg L.P.