The euro, seen as a potential failure 10 months ago, had its strongest start to a year on record as German growth accelerates and policy makers prepare to boost interest rates.
The currency appreciated 3.5 percent through March, the most since the final three months of 2008 and the best first- quarter performance since the region’s single currency began trading in 1999, according to Bloomberg Correlation-Weighted Index data. It rose from its lowest level since 2002 in January as German Chancellor Angela Merkel and French President Nicolas Sarkozy said they would do whatever is needed to support the 17-nation monetary union.
While Portuguese bonds show increasing speculation for a default and regulators said four Irish banks need to raise 24 billion euros ($34.1 billion) in capital, currency concerns have faded since last year, when former Federal Reserve Chairman Paul Volcker and billionaire investor George Soros said the union may dissolve. No countries have restructured debt yet and economic growth led by Germany has caused the European Central Bank to signal it may raise rates as soon as this week.
“The euro is extraordinarily strong under the circumstances,” said Alan Ruskin, global head of Group-of-10 foreign-exchange strategy at Deutsche Bank AG in New York. “Does it look more capable of stumbling along than it did a year ago? Yes, to the extent that the core does seem to have made a commitment to fund bailouts.”
‘Tearing Itself Up’
Last year, as head of international currency strategy in North America at Royal Bank of Scotland Group Plc, Ruskin said the euro was “tearing itself up from within” and estimated a yearend rate of $1.28. Instead, it finished the year at $1.3384. Ruskin still estimates the euro will weaken, to $1.30 by year-end from $1.4237 on April 1. The euro was at $1.4226 as of 11:06 a.m. in Tokyo.
Greece, whose overwhelming debt helped trigger the crisis, faced a potential “death spiral” because the cost of borrowing from a region-wide rescue program was too expensive, Soros said on April 13. Volcker said four weeks later that Greece’s fiscal crisis and subsequent bailout may break up the euro zone. At $330 billion, the Greek economy is less than 25 percent the size of Spain’s, the fourth biggest in the common currency area.
Now, bears are citing Portugal, Ireland and higher interest rates as reasons to be concerned about the currency.
The extra yield investors demand to hold Portuguese 10-year securities instead of German bunds widened to 5 percentage points last week for the first time since at least February 1997, when Bloomberg began collecting the data. The country’s prime minister resigned March 23 after opposition parties rejected his deficit-cutting plan.
Last week, officials instructed four of Ireland’s biggest banks to raise 24 billion euros and announced plans to merge two of them. The government already injected 46.3 billion euros into the financial services industry and set up an agency that paid more than 30 billion euros for banks’ risky property loans in the past year. The total equates to about two-thirds the size of the Irish economy.
The ECB boosted its forecast for inflation this year, predicting that price increases will exceed its target through 2011 as the economy strengthens. Consumer-price increases will average 2.3 percent, up from a December forecast of 1.8 percent, the central bank said on March 3, the day of its last policy meeting. ECB President Jean-Claude Trichet said on the same day that “strong vigilance” is required on prices.
The ECB’s refinancing rate will probably end the year 1.5 percentage points higher than the Fed’s main rate, according to Bloomberg News surveys of economists. The ECB rate will rise 75 basis points to 1.75 percent while the Fed’s will stay at a range of zero to 0.25 percent, the surveys show.
While removing stimulus may make assets denominated in the common currency more attractive to investors searching for higher yields, they may come too early for some of the so-called peripheral countries and endanger the economic recovery.
“For some countries a rate hike doesn’t fit, especially for Portugal and Greece, but also partly for Spain, where there is a problem with mortgages,” said Ulrich Leuchtmann, head of foreign-exchange strategy in at Commerzbank AG in Frankfurt, who expects the euro to end 2011 at $1.32 as the Fed begins to reduce its aid to the economy. “We’ll have a rate hike, and this will obviously create problems.”
John Taylor, chairman of New York-based FX Concepts LLC, the world’s largest foreign-exchange hedge fund, predicted in January that the euro may fall below parity with the dollar this year. Now he says the current rally may not last. Taylor, whose firm oversees about $8.5 billion, profited in the first half of 2010 betting on a slide in the currency.
“I’m sounding pretty stupid; but on the other hand, I’m not ashamed and I’m sticking with it,” Taylor said last week in a telephone interview. “Europe, with all the tightening that’s being forced on these countries, will be in a recession by the end of the year. There’s going to be a restructuring and default of the European debt.”
The euro hit a four-year low against the dollar on June 7 as debt turmoil drove it to $1.1877. It has since appreciated 20 percent, reaching a four-month high of $1.4269 today. The euro strengthened 1.1 percent last week.
The Bloomberg euro index measures the currency against those from the Group of 10 nations proportioned by how they trade against each other. It has a base value of 100 and rallied to 101.839 after dropping to a more than eight-year low of 96.4715 on Jan. 11. The index for the dollar has fallen to 92.8668 from 97.9994 in the same period.
‘Whatever is Needed’
Merkel has said she will do “whatever is needed to support the euro,” and promised that meetings scheduled for March 11 and on March 24 and 25 will produce a “comprehensive” solution to the crisis. Sarkozy said the monetary union is so important “that we will be there whenever it needs to be defended.”
The euro zone’s economy expanded 1.7 percent in 2010, and may grow by the same amount in 2011, according to the median estimate of 19 economists surveyed by Bloomberg. Core countries led by Germany, which makes up 30 percent of the region’s gross domestic product, are leading the growth.
Germany’s economy expanded 3.6 percent in 2010, the most in two decades, even as Greece and Ireland contracted and governments across the region cut spending. German’s benchmark DAX Index of stocks has climbed 3 percent in 2011, after rising 16 percent in 2010 as sales outside of Europe fueled company earnings. Spain’s IBEX 35 Index is up 8.8 percent since December.
Europe’s parliament approved the formation of a permanent European Stability Mechanism last month to succeed last year’s 440 billion-euro, three year-European Financial Stability Facility created to assist highly indebted countries.
Spanish and Italian bonds have rallied on speculation the crisis will be contained as they reduce deficits. While Spanish 10-year bond yields, at 5.31 percent, are about 100 basis points above the average of the past five years, the nation’s debt returned 2.3 percent this year, after posting the biggest loss since 1994, Bank of America Merrill Lynch indexes show. Italian bonds have returned 0.78 percent.
“The market can whip you up into a frenzy where you become irrational,” said David Bloom, the global head of currency strategy at HSBC Holdings Plc in London, who said in June the euro would end 2010 at $1.35. “The difference this time around is that there is a mechanism in place. The break-up premium has come out of the euro.”
© Copyright 2014 Bloomberg News. All rights reserved.