(Bloomberg Opinion) — The euro is becoming the go-to currency for safety and liquidity as we approach the U.S. presidential elections and investors bet on a rocky time for the dollar. This may be a source of pride for European policy makers in how they’ve handled the pandemic so far. Unfortunately, it’s a potential problem for exporters on the continent, not least its manufacturers.
As Kit Juckes, a currency analyst at Societe Generale SA, puts it: “The dollar’s very overvalued but the euro isn’t very undervalued.”
With signs that hedge funds are taking option exposure on a rising euro, the recent move into the single currency could easily turn into an investor stampede if dollar flight takes hold. As I’ve written before, this would put European Central Bank Governor Christine Lagarde in a very tight spot because she’d find it hard to fight against an overly strong euro. The ECB doesn’t have an official mandate to manage the currency, but its actions definitely help. It is close to being maxed out on policy responses as it already has a giant pandemic bond-buying program and deeply negative interest rates.
The minutes from the July meeting of the ECB’s governing council, released on Thursday, noted that several policy makers questioned whether the 1.35 trillion-euro ($1.6 trillion) quantitative-easing program for the pandemic should be fully used. That’s not a sign that printing more euros, or taking measures that would weaken the currency’s ascent, are available options.
Isabel Schnabel, the ECB’s executive director for market operations, also said optimism in the financial markets (read all-time highs for U.S. stock markets) “raised questions regarding the robustness and resilience of current investor sentiment.” She has a point. If the S&P 500 index were to correct sharply it would push the dollar lower, and the biggest beneficiary could be the euro as it’s the next most liquid currency. The euro area relies on exports for growth, so this could choke a Covid recovery.
There’s also a widening gap between America’s economic sentiment and its stock performance. The U.S. Federal Reserve’s minutes from its July 29 meeting gave a gloomy assessment of the economy, downgrading second-half growth estimates. Weekly U.S. jobless claims rose by more than 1 million. For some investors, this is an obvious risk to start hedging against.
The effect is showing up in the bond markets too. Wednesday’s auction of 30-year German bonds was the best on record in terms of demand, despite offering a negative yield. This was reportedly driven by foreign interest. It makes sense for Japanese pension funds and insurers to hedge some of their foreign-currency bond exposure out of the dollar if they fear it will weaken further.
With the European Union finally joining up its fiscal and monetary response, it might end up being a victim of its own success. The euro area doesn’t need to perform particularly well economically to attract inflows as it’s simply the next best place to park money after the U.S. If the dollar does lose its shine, the euro could become too popular for its own good.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.
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