U.S. rates and political upheaval puts the euro under pressure

06.07.2018
The euro is under pressure and has fallen by around 7.0 percent over the past few months. In 2017, the euro was able to defy the headwind caused by the yield spread and stand strong to the USA because of a surprisingly healthy economic development. However, the OECD’s leading indicator (CLI) has now turned downwards for the Eurozone and points towards a continued rapid deceleration towards the end of the year.

So writes Chief Strategist at Sparinvest David Bakkegaard Karsbøl in his latest monthly comment.

Another reason for the weakening of the European position is probably due to the fissures in the European collaboration becoming bigger after the election of the new Italian government, which is challenging the accepted methods and ideas of the EU elite alliance of France and Germany on a number of crucial issues.

The EU collaboration’s political problems mentioned above can, in themselves, be a problem for the value of the euro, but as the difference between American and European interest rates has also expanded to the biggest spread in many years – and according to the American Central Bank - Fed - they will be expanded even more over the next few years – it is no surprise that the USD is rising in relation to the EUR.

The current difference between 2-year rates between U.S. and German government bonds is 3.2 percent, which is the highest it has been since 1997. The difference in 10-year rates is 2.57 percent.

If the U.S. Central Bank carries on raising interest rates throughout the rest of 2018, the unchanged long term interest rates will experience a so-called inverted interest rate curve, which has always been an early sign of an approaching recession (typically 12-18 months after the short rates started to be higher than the long rates).

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