The euro has been a star performer in 2017 and it looks like it could be set for further gains as we head into the second half of the year.
Euro net long positions as recorded by the US Commodity and Futures Trading Commission jumped to their highest level in 6 years, while the number of net long positions in the dollar has slumped to their lowest since last August.
The divergence follows a rise of more than 6% this year for EURUSD despite the Fed’s double hike and the persistent accommodative stance of the European Central Bank (ECB).
Undoubtedly the success of Emmanuel Macron has helped the euro. Political risk was a big factor early in the year as investors fretted over the French elections in the context of Brexit and a possible disintegration of the Eurozone itself. Macron seems have doused all the fears and we seem to be witnessing political risk recede across the EU.
What Macron can achieve is another matter. He has a parliamentary majority but transforming the French economy is not going to be easy. Significant hurdles are still in his path and if fails to clear them – a standoff with unions looms – then all this positive sentiment could evaporate. It’s worth noting that while Macron won fairly easily, turnout was low and support for hard-left or hard-right candidates was extremely high. The forces of anti-globalisation, populism and disenchantment with the economic system have not any way diminished.
Economic growth is picking up the Eurozone at the same time as political risks receded. Corporate earnings are accelerating and there are signs that it’s not just Germany doing all the heavy lifting.
Growth is now expected to hit 1.9% in 2017, according to the ECB’s latest estimates, compared with its March forecast of 1.8%. The 2018 and 2019 forecasts were also revised higher. Critically the ECB also thinks risks are now “broadly balanced”, as opposed to “tilted to the downside”.
The Ifo think tank has revised up its forecast for the German economy this year to 1.8% from a previous estimate of 1.5%. The French economy is set for its best annual GDP growth since 2011. According to Kepler, tax reforms could boost French corporate earnings by 12%. Morgan Stanley thinks France’s growth will outpace the UK and Italy in 2018.
Growth may be picking up, but inflation remains obstinately subdued. The ECB downgraded its outlook on inflation in 2017 to 1.5% from a previous estimate of 1.7%.
CPI in the euro area has failed to take off after a couple of false starts. Core CPI is also lagging and in May fell to 0.9% from 1.2% in April. The lack of inflation underscores the ECB’s desire to sit on its hands until it views the growth in prices as sustainable without monetary policy support. Hence why the bank sees no real room to tighten soon, in spite of increased pressure from some quarters to do so. The longer the ECB fails to give euro bulls what they want, the more likely investors will run of patience.