Euro: Medium-term Trend Remains Weak

Since June, the US stock market has ended its unilateral upward trend, returning to a more volatile pattern, and the yield gap between US and European equity assets has narrowed. However, the euro continued its weak performance and did not gain significant upward momentum from the volatility in the equity markets.

Why is this happening, and what lies ahead for the euro? Let’s look into several dimensions:

First, from the perspective of capital flows, due to the valuation resilience of US AI leaders, dollar-denominated asset allocation remains attractive.

During the period from June 26 to July 2, foreign inflows into US equity ETFs and mutual funds totaled $3.8 billion, maintaining positive growth. Looking at the entire month of June, total inflows into these funds reached $13.8 billion, the highest level since $16.1 billion in January 2025.

In addition, carry trades related to the US-EU interest rate spread are also an important constraint on short-term EURUSD fluctuations. The warming of market risk appetite has caused the VIX reading to continue falling. In a low-volatility environment, funds are more willing to engage in carry trades, and the interest rate spread may continue to dominate EURUSD movements for a period of time.

The continued divergence in economic performance provides medium- to long-term support for a “strong US, weak Europe” scenario. Major economic data show the US has both higher economic growth momentum and inflation stickiness compared to the eurozone. Up to the present day, the fundamental divergence between the US and Europe continues to widen.

Looking ahead, different paces of AI industry development in the two regions may further widen the gap in US and European economic fundamentals:

As the country at the forefront of AI advancement, the minutes of the latest Federal Reserve FOMC meeting show that officials’ concerns about future inflation trends are rising. Compared to before, more officials are now identifying the corporate investment boom driven by AI infrastructure as a new source of persistent inflation for the first time.

A Goldman Sachs research report delved deeper with data analysis: whether in hardware or software, America's PCE inflation metric contains many components related to this. The impact of AI development on US PCE is much greater than in other developed countries.

As for Europe, as pointed out by an ECB paper, due to the constraints of the productivity J-curve, there is a lag in reaping the growth dividend from digital investment. Europe has suffered from long-term insufficient investment in intangible assets and ICT-related sectors; this structural imbalance has continued to widen the US-Europe output gap, exerting medium- to long-term pressure on the European economy.

To summarize today’s discussion:

1. Although the US stock market is volatile and the US-Europe equity yield gap is narrowing, high-valuation AI-related assets remain highly attractive to foreign capital. Inflows into US equity ETFs and mutual funds remain positive, while EURUSD continues to be weak;

2. With the return of market risk appetite, the US-Europe interest rate spread is an important constraint on short-term EURUSD volatility, while the persistent divergence in economic fundamentals underpins a medium- to long-term “strong US, weak Europe” narrative;

3. Looking forward, US concerns about AI’s contribution to inflation and Europe’s continued lack of related investment will further widen the economic gap between the US and Europe for some time.