Euro: Recovery does not justify stronger EUR – BNY

BNY’s Geoff Yu argues that while Eurozone growth and inflation risks are real, being long the Euro (EUR) is not the best way to express this view. Yu highlights strong industrial data and fiscal support that favor European assets, but stresses weak demand, European Central Bank (ECB) policy-error risk and rich EUR valuation. It recommends EUR-funded carry trades instead.

European recovery but weaker euro

"Bottom line, Europe’s recovery is real, and inflation risk is real. Long EUR is the wrong expression for these views. Industrial and fiscal support favor European assets, while weak demand, policy-error risk and rich valuation weigh on the currency."

"The recovery is not yet broad based. German services fell to 48.5, confidence weakened and output-price inflation eased for a third month. Across Europe, inventories, defense and data-center investment are supporting industry, but the demand and core inflation impulse remains insufficient to justify sustained EUR appreciation."

"Outright EUR positioning is strong now, while cross-border hedges sit nearly 60% below their one-year average. Dollar reductions following the July FOMC have left investors materially underhedged on Eurozone assets. With EUR rich and its rate differential against USD still negative as the Fed steps up tightening, currency hedging should rise even if allocations to Europe continue."

"EUR remains overvalued. It’s nearly 2% above its one-year BIS REER average; the currency is expensive in real terms but relatively cheap to borrow."

"Using EUR as a funder is not a negative view on the Eurozone. European equities can outperform alongside a weaker currency, while unhedged allocations face a drag if REER normalizes. EUR-funded carry benefits from the same adjustment."