Euro: Recovery holds as currency softens – BNY

BNY’s Geoff Yu argues that the Eurozone recovery remains intact even as the Euro (EUR) weakens. Manufacturing PMIs and business surveys in Germany and across Europe point to strengthening demand, while fiscal stress and a softer European Central Bank (ECB) stance weigh on the currency. The bank maintains its view that the Euro will decline despite stronger economic performance.

Growth resilient as Euro slides

"Last month, we argued that the Eurozone economy was recovering, led by broad-based gains in manufacturing. The Eurozone manufacturing PMI held at a four-year high in September, while factory output is expanding at its fastest pace in nearly five years. New orders and backlogs continue to rise, pointing to a clear strengthening in demand."

"Stronger data and another ECB rate hike haven’t prevented a 1.4% decline in the EUR’s nominal effective exchange rate since the beginning of September. The decline began well before concerns about France’s fiscal position became a central source of weakness and volatility. At the time, the euro was overvalued and interest-rate expectations appeared stretched, while limited short positioning and hedging left room for adjustment."

"Lagarde has already acknowledged that current front-end interest-rate levels would “slow growth.” Recent moves in global bond markets are tightening financial conditions further through the fiscal channel, a point echoed by ECB Chief Economist Philip Lane. The French government has announced fiscal consolidation measures, with legislation expected to pass in Q4."

"Consequently, expectations for year-end ECB rates have fallen below pre-decision levels, adding to EUR weakness."

"Unlike in 2011–2012, we see no spillover from OAT volatility into FX markets. Ten-day realized EURUSD volatility remains within its range since May, even as realized volatility in OAT futures has spiked. The ECB’s retreat from firm rate guidance has already helped dampen volatility."