The move consolidated a rally in the single currency that was triggered by an upbeat performance from Mario Draghi, European Central Bank president, after this month’s policy meeting. That has combined with increasing evidence that investors are returning to peripheral eurozone bond markets to support the single currency, sending it on a storming start to 2013.
Crucially, the euro has also been supported by rising eurozone money market rates as investors re-assessed the desire of the ECB to provide more monetary stimulus. Indeed, prior to Draghi’s confident performance there had been speculation that the central bank was considering reducing rates to boost peripheral eurozone economies.
Compounding that, the prospect that excess eurozone liquidity will fall as more banks than expected in the region pay back three-year LTRO funds to the ECB at the first opportunity on January 30 has also lifted eurozone rates and supported the euro.
That move in rates was given added impetus on Wednesday after a smaller than forecast take-up by banks of three-month LTRO funding – some had been expecting banks would replace long-term LTRO funding with shorter-term financing.
The net result of the tightening of eurozone financial conditionshas seen rates in the region rise above those in the US. German two-year rates, for example, are one to two basis points above their US equivalent – just two months ago the US was offering 30 basis points more than Germany.
If that was not enough, the euro has also been supported by the view that policymakers in the region are less concerned over strength in their currency than their peers across the globe.
That assumption that the European policymakers will stay on the sidelines of any global currency war was given credence on Wednesday by ECB board member Ewald Nowotny. He said the euro remains “within a normal long-term range” and that the currency was rising because of an improved economic outlook.
Indeed, even hopes of an improvement in the eurozone’s economic performance supported the euro on Wednesday, as investors pointed to improved regional economic confidence data.
Still as EURUSD pushes higher, taking out barriers like a knife through butter to its strongest level in over a year, some are uneasy that the gains will last.
Kit Juckes, head of FX strategy at Société Générale, says the euro is being propelled higher by tighter monetary conditions at a time when the region’s economy needs a weaker currency.
“So we go up – to EURUSD $1.37 next, $1.40 possibly – and then down later,” he says.
Camilla Sutton, chief currency strategist at Scotiabank, points to the fact that while an improvement in eurozone confidence was welcomed by the market on Wednesday, worse than expected Spanish GDP figures were ignored.
The euphoria over the single currency is, in other words, drowning out the reality of the problems still confronting the eurozone.
“We do think there has been an important shift in euro sentiment, but fear that as the euro climbs markets are beginning to under-price the risk that lies within European politics, negotiations of the banking union, the impact of a strong euro on the underlying economies and the ECB outlook,” says Sutton. “We have made no change to our year-end EURUSD target of $1.27.”
Even euro bulls are nervous at the pace of the currency’s recent rise.
EURUSD has now hit Rabobank’s $1.35 year-end target, for instance.
“While our view that central bank accommodation coupled with expectations that the EMU crisis is moving closer towards a resolution will hold up risk appetite has essentially been vindicated, the move to $1.35 has been more rapid than we expected,” says Rabobank FX strategist Christian Lawrence.
“As a consequence we have been left feeling slightly uncomfortable even though our forecast has been hit.”
Lawrence says the main source of that discomfort stems from the view that investors’ desire to move into riskier assets is counter to the bias of forecasters such as the International Monetary Fund, World Bank and the OECD towards revising lower estimates for world growth this year.
He says while the bank has been arguing that the outlook for the survival of EMU started to improve last July when politicians underpinned the need for fiscal union, there is still the potential for hiccups along the way.
“As a consequence, while we remain of the view that central banks will continue to support risk appetite this year and EURUSD will retain an upwards bias, we would also warn that there is potential for pullbacks and investors should remain on their toes.”
Above $1.35 in EURUSD, the euro may already be punching above its weight.