Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why the Euro Is Falling Despite Higher ECB Rates
Transcript
- Lucas: The euro is down about four and a half percent against the dollar this year, and it hit a fresh 2026 low last week. That's despite the European Central Bank holding its deposit rate at three point seven five percent and Christine Lagarde leaving the door open to an early exit strategy. Luna: Which is weird, right? Normally a central bank signaling tighter policy supports the currency. So what's breaking that link? Lucas: Yeah, it's a classic case where politics overrides monetary policy. The biggest factor is French political uncertainty. President Macron's government is struggling to pass a budget, spreads between French and German bonds have widened, and foreign investors are pulling back. The euro is a bet on the entire bloc's stability, and France is roughly a fifth of eurozone GDP. Luna: So the market is pricing in a risk premium for France, which drags the whole currency down. That makes sense. But is there also a growth story here? Because the US economy is still growing at two point one percent annualized while the eurozone is hovering near zero. Lucas: Exactly. Real GDP in the eurozone grew just zero point three percent in the first quarter. Meanwhile, the US added fifty-seven thousand jobs in June, and the unemployment rate ticked down to four point two percent. The growth differential is stark. And on top of that, energy costs in Europe are still elevated because of the shift away from Russian gas. That hits manufacturing and trade. Luna: And that trade channel matters a lot for currencies. Europe exports a ton of capital goods and luxury goods. If the euro is weak, it helps exporters, but it also makes imports — especially energy — more expensive. So it's not an unalloyed good. Lucas: Right. And then there's China. We saw that China's consumer price growth weakened again in June, while producer inflation hit a near four-year high. That tells me Chinese demand is soft, and they're exporting deflation in industrial goods. That hurts European exporters who compete with China in third markets. Luna: So the euro is getting squeezed from multiple sides: political risk in France, sluggish growth, energy costs, China deflation. But what about inflation itself? Core CPI in the eurozone is still at two point nine percent — above the ECB's target. Shouldn't that keep the currency supported? Lucas: It should, but markets are looking through that. They see sticky inflation driven by services and wages, but they also see a weakening economy. The market is pricing in about fifty basis points of ECB cuts over the next twelve months. Compare that to the Fed, where the effective funds rate is three point six three percent and markets expect maybe one cut. So the interest rate differential is actually widening in favor of the dollar. Luna: And that's despite the Fed being stuck at three point six three percent. The ten-year Treasury yield is at four point five four percent, while the German bund yield is around two point five. The spread is over two hundred basis points. That's a huge pull for capital into dollar-denominated assets. Lucas: It is. And I think this brings up a bigger question about how we think about currency valuation. For years, people said the euro was undervalued on a purchasing power parity basis. But in a world where capital flows dominate trade flows, PPP doesn't matter much. What matters is where capital wants to go. And right now, capital wants dollar safety and yield. Luna: Let me jump in here with something personal. You know, producing a show like this — digging into macro data every day — takes a lot of time. And we're able to keep it ad-free because of a small group of listeners who chip in monthly through buy me a coffee dot com slash fexingo. It's listener-funded, no sponsors, no banner ads. Just people who find value in these conversations. Lucas: Totally. And we don't ever want to put that behind a paywall. The whole point is that macro should be accessible. So if you've gotten something out of these episodes and you're in a position to throw in a few bucks a month, that's what keeps the lights on. Seriously, it makes a difference. Luna: Alright, back to the euro. One thing I haven't heard much discussion about is how a weaker euro affects European corporate earnings. A lot of European companies report in dollars, so a weaker euro actually boosts their reported revenue. Could that be a silver lining? Lucas: It is, for exporters. Companies like LVMH, Siemens, and ASML get a translation boost. But the flip side is that input costs — especially energy and raw materials priced in dollars — go up. So it's not a pure win. And for the ECB, a weaker euro adds to import inflation, which complicates their fight against sticky core inflation. Luna: So Lagarde is in a tough spot. She has to talk tough on inflation to keep expectations anchored, but the economy is weak, and political risk is rising. If she sounds too dovish, the euro falls more. If she sounds too hawkish, growth slows further. Lucas: Exactly. And I think that's why we've seen the euro trade in a relatively tight range despite the downward drift. The market is waiting for a catalyst — either a clear signal on French fiscal policy, or a decisive move from the ECB. In the meantime, the dollar is the default safe haven. Luna: And what about the Fed? Does a weaker euro affect their thinking at all? Lucas: Indirectly. A stronger dollar tightens financial conditions here by making exports more expensive and reducing the dollar value of foreign earnings for US multinationals. But the Fed's focus is domestic: inflation and employment. With core PCE at two point six percent and the labor market still tight — job openings at seven point five nine million versus six point eight million unemployed — they're not in a rush to cut. The dollar strength is more of a headwind for US earnings, but not a policy driver. Luna: So to wrap it up, the euro's weakness is a story about politics, growth differentials, and capital flows, not just ECB rate policy. And it's likely to persist until we see either a resolution in France or a meaningful turnaround in eurozone growth. Lucas: I think that's right. And it's a good reminder that currencies are the closest thing we have to a real-time referendum on a region's economic and political health. The euro has been under pressure for months, and the data suggests that pressure isn't letting up soon.