July 31, 2020 / 6:03 AM / 8 days ago

COLUMN-Euro's rise not 'brutal' enough, yet: Mike Dolan

(The author is editor-at-large for finance and markets at Reuters News. Any views expressed here are his own)

By Mike Dolan

LONDON, July 31 (Reuters) - The speed of the euro’s 10% surge against the dollar over the past 100 trading days is aping the sort of ‘brutal’ currency moves the European Central Bank has moaned about in the past.

So far at least, there’s been barely a reference to the move from policymakers. Or indeed from euro area exporters.

Reeling from the pandemic shock to the world economy, both parties have other fish to fry right now perhaps.

Currency markets have mostly focused on the flipside of the pair - the retreat of the U.S. dollar as pandemic-related funding stress dissipates, the likely prospect of even further easing from the Federal Reserve and a looming U.S. election.

And euro positivity has been rooted in ‘good news’ developments - Europe’s post-virus fiscal support plans and a related reduction of euro break-up risks, as well as the region’s relatively more successful virus control to date.

But isolating the European side of the equation, the trade-weighted euro’s rise does look like a burn for a central bank trying to ward off deflation risks and for exporting companies already under severe stress from such a deep world recession.

The euro hit its highest levels in six years this week - up more than 7% in just 160 trading days. The last time it rose that far that fast was in 2017 - when then ECB chief Mario Draghi warned its steep climb was a “source of uncertainty” for price stability.

The ECB has regularly met rapid euro surges with verbal intervention over the course of its 21-year history.

Draghi cited euro trade-weighted gains of more than 10% in 18 months to early 2014 as a “cause for serious concern” in the light of low inflation.

And Draghi’s predecessor Jean-Claude Trichet was fond of using the word “brutal” to describe steep euro snarl-ups by way of signalling the central bank’s displeasure - the first in early 2004 after gains of 20% in 18 months and again in 2007.

MUM SO FAR

But there’s been little or no obvious reference to the euro move from ECB officials so far.

In an interview with Reuters last month, ECB chief economist Philip Lane referred only to how the central bank watched markets closely because of its concern about wider financial conditions - and how markets and the central bank tended to be on the same page.

The problems presumably arise then when they deviate.

With Germany on Thursday registering annual inflation of 0.0% for July - far lower than forecast - a surging euro can hardly be helpful to the central bank hitting its inflation target while long-term, market-based inflation expectations remain barely over half that 2% goal.

That said, corporate Europe has also been quiet about the currency as it faces bigger issues wheeling out dramatically ugly second quarter earnings due to the pandemic.

Investors too seem relaxed. The latest strategy updates from two of the world’s top asset managers - Blackrock and Amundi -barely mentioned the euro rise - even though the former re-iterated its preference for European over U.S. equities and the latter downgraded its view on euro/dollar to ‘neutral.”

Barclays reckon European equity and the euro can continue to rise further as they are both benefiting from Transatlantic investment flows and justified by fundamentals.

“We believe that the fast rebound in euro/dollar is not yet an impediment to the performance of euro zone equities, as the correlation between the two was mostly positive after the GFC (global financial crisis),” said its European equity strategy head Emmanuel Cau.

And for all the fury of the recent move, the euro’s trade-weighted index has curiously just returned to where it started life in January 1999 - having been about 12% above this and more than 21% below over the intervening 21 years.

Although it surged briefly above 10% as the pandemic hit, implied 3-month volatility in euro/dollar options remains relatively subdued just above 7% - half the peaks hit during banking and euro crises of the past 12 years.

What’s more, JPMorgan’s analysts reckon that much of the recent euro rise was driven by speculative flows and corporate hedging and these look to have to run their course for now.

Still, some FX funds, such as Millennium, have pegged ‘fair value’ for the euro/dollar another 5% higher than current rates and currency markets have a long tradition of momentum-driven moves that overshoot.

With few reasons to embrace the dollar ahead of November’s elections, an accelerating euro rise may yet turn ‘brutal’.

by Mike Dolan, Twitter: @reutersMikeD. Graphic by Ritvik Carvalho Editing by Susan Fenton

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