The euro: the growth currency of the developed world

The recent bout of weakness in global economic data has coincided with a surge higher in EURUSD above 1.4500 and EURGBP above 0.8900.

It’s worth taking another look at the drivers of the euro’s recent rally.

1, The euro is trading in line with relative growth expectations between Germany and the US/ UK. German growth is holding up very nicely, and although it has come off its highs, the economic indicators are much stronger for Berlin than they are for the UK and the US. According to Bloomberg, analysts predict the US to grow by 2.7% this year, the UK at 1.4% and Germany to out-pace them both at an extremely healthy 3.25%, well above the 1.14% average for German growth over the last 7 years. So the euro is piggy-backing off Germany’s growth trajectory.

The chart below shows EURUSD (white line) and US ISM manufacturing, which has a close relationship with GDP. The chart has been normalised so you can see how they both move in relation to eachother. As you can see, the euro has recently moved higher as the ISM has collapsed. This suggests the euro is acting like the proxy for growth in the developed world.

But alongside the strong Germany growth story is the peripheral debt crisis. However, as we have said before, unless this crisis spreads to Spain we don’t think it will hurt the euro too much. The euro has an inverse correlation with the cost to insure Spain’s government debt against default (orange line on chart below). As long as the crisis doesn’t spread to Spain then it is considered manageable. In comparison, even as Greece’s problems escalate, rising bond yields in Athens have little impact on the euro (as you can see below: Greek bond yields green line, EURUSD white line). However, the moderation in Greek yields on Friday caused by reports that the IMF/ EU and ECB are discussing another bailout for Greece probably won’t hurt sentiment towards the single currency, at least in the short term.

Source: Forex.com

06.06.2011