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Euro Bulls Fired Up As German Coalition Talks Push Common Currency To Three-Year High

Long euro may be a crowded trade, but by God it's worked out pretty well over the past couple of days. 

Long euro may be a crowded trade, but by God it’s worked out pretty well over the past couple of days.

You’ll recall that the common currency got a boost from news that China is planning on diversifying its FX reserves away from U.S. Treasurys which of course suggests that euro debt will be the preferred alternative. Recall what BofAML wrote about this on Thursday:

The announcement is timely as it coincides with President Macron’s official visit and an interesting takeaway from the comments is that China officials have cited trade tensions as a factor in their decision. With politics in the Euro Area on a more stable footing, improving macro fundamentals and the end of ECB QE in sight, the EUR as a reserve currency appears to be an increasingly attractive long-term proposition.

As far as the whole “the end of ECB QE in sight” bit is concerned, that’s debatable, but the ECB minutes (out Thursday) were generally seen as hawkish and don’t forget that earlier this month, Benoit Coeure (speaking to Caixin Global) said this:

Given what we see in the economy, I believe that there is a reasonable chance that the extension of our asset purchase program decided in October can be the last.

The Governing Council has also made it clear that the program can be kept in place for longer, should inflation disappoint on the downside. And if inflation turned out to be higher than currently expected, we would have plenty of instruments with which to react.

The going assumption was that while APP would be tapered further nine months from now, it would be extended through December – i.e. not terminated completely. What Coeure is suggesting is that new purchases may come to a complete stop in September. That probably lent credence to the hawkish interpretation of the minutes.

Then, on Friday morning, we got this:

  • MERKEL, GERMAN SPD ARE SAID TO REACH PRELIMINARY DEAL IN TALKS

Obviously, that’s big news and it buoyed the single currency further as it underscores the idea that, as BofAML put it on Thursday, “politics in the Euro Area [are] on a more stable footing.” Here’s the annotated chart:

EURUSD

That’s a three-year high:

EURUSD2

If you’re a euro bull, this is great because not only is it good news for political stability in the bloc’s most important country, it also helps Emmanuel Macron in France.

“The conclusion from the progress in the German coalition talks is that it opens up for the possibility that French President Emmanuel Macron will gain support for his agenda,” Swedbank’s Anders Eklof told Bloomberg by e-mail, adding that “this would improve preconditions for raising the euro area’s potential growth rate and creates opportunities to move closer on creating a more common tax and budget policy, which is fundamental to the euro’s long-term survival.”

Ok, but a couple of things. First, you don’t want too much euro strength if you’re a European equity bull. The single currency’s 2017 surge (its best year against the dollar since 2003) played a role in the European equities’ underperformance versus global peers. Perhaps more importantly, you can expect Draghi to push back if the common currency runs too far; especially given that inflation is expected to remain subdued for years.

So the euro bulls might want to curb their enthusiasm – after they’re done celebrating of course.

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