When I wrote a couple of days ago about my conversations with a few macro hedge funds, I mentioned that on the euro the message was that most were bearish on the political side, but remained reluctant to convert that thinking to short positions. Today is a graphic example of that.
When someone with the background and credibility of Herr Weber (to mention just one!) highlights the enormous structural problems still at the heart of the unified currency bloc, it should be enough to make any euro bull think twice. What happens – barely a shiver, and then the euro goes bid on the back of some daft PMI numbers! Basically then no change from last year. The dynamics behind this seemingly odd situation is nothing new; capital flows into the euro, as a move away from the brink has reduced the risk premium for euro denominated assets; central banks rebalancing their holdings, and repatriation of euros by European banks ahead of the banking tests later this year. At the same time there is a spent bearish speculative contingent providing no real opposition.
Just to expand on the euro conversations I had, my feeling was that the euro had been largely sidelined for speculative purposes; simply because they were bearish, but that had only lost money, and at the same time there was certainly no appetite to buy at these levels. I think this encapsulates what a lot of the forex market feels. As we all know, there is no point in continually losing money short term, because of a long term view, and many who cannot bring themselves to go long euros have found more rational alternatives. For the ECB the current situation also presents somewhat of a dilemma. They understand the fragility of the situation I am sure, and therefore find themselves unable to mention the unwelcome but additional problems being caused by euro appreciation, for fear of unleashing pent up selling pressures.
So to summarise, we came pretty close to a complete fracture of the common currency 18 months or so ago. The outlook now AT WORST, is that one or two weaker members MAY have to leave the bloc at some indeterminate time, possibly through internal politics. Even that event would not prove disastrous, and the euro would go on, possibly on an even stronger footing. This change in status has been defining, as the risk premium that I referred to earlier has diminished hugely, therefore enabling long term investors to rebalance their holdings with confidence. So once this rebalancing is complete, we will see potential for movements down of course, but the efforts of the ECB and the resolution of Mr Draghi have been absolutely fundamental in assuring investors that the euro is here to stay – hence the relief led appreciation. That effort has given time for a better global outlook to gather the eurozone with it, and generally improve the outlook in a lot of the member countries. So still not the land of milk and honey by any means, but equally the fear of investments landing up in court to sort out residual component currency value has receded, and that is a huge plus!
