After the November election, investors overwhelmingly favored the US, largely considering it the only game in town for exceptional growth and equity performance. Meanwhile, market sentiment remained strongly negative on Europe and the rest of the world. However, recent events signal a potential growth convergence underway that would reorder the global economic backdrop. There are several forces—separately or combined—that we expect to drive appreciation in the euro.
With the US economy already slowing, the Trump administration’s aggressive tariff policies and immigration crackdown may intensify the growth slowdown and undermine the country’s longstanding economic exceptionalism. Downside risks to growth are numerous, including direct layoffs, delayed hiring, reduced consumer and business spending, knock-on effects to contractors from deferred projects, a drop-off in tourism, etc. Financial markets appear to be waking up to the material growth risks, evidenced by recent selloffs in equities, lower bond yields, and dollar weakness. As hard economic data begins to more clearly reflect the impact of these policies, the dollar could sell off further, benefiting other currencies, including the euro.
At the same time, there are signs that European growth could be stronger, and European bond yields could be higher. A major catalyst is Germany’s announcement of a massive fiscal boost, which has led to a significant repricing of European rate expectations relative to the US and a significant repricing of the euro. This regime shift is another main reason for the US dollar’s selloff. Beyond Germany’s announcement, expectations for higher defense spending and increased fiscal stimulus across the currency bloc should ultimately boost the euro. Lastly, the euro also stands to benefit from a resolution to the Russia-Ukraine war, which would reduce geopolitical risk and uncertainty.
What is the potential fair value for the euro? On a historical basis, if 1.20 to 1.30 EUR/USD is a reasonable range for long-term fair value, there remains plenty of room on the upside for the euro to break out of its funk and move toward a more normalized expression.
Paul Mielczarski
Head of Global Macro Strategy & Portfolio Manager
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