Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / Why the Euro Is Defying Its Old Weakness Reputation
Transcript
- Lucas: If you've been watching currency markets this spring, you've probably noticed something unusual — the euro is holding up. Actually, it's quietly strengthening, even as the Eurozone economy grows at a modest one-point-six percent annualized rate and energy prices stay elevated because of the conflict in Iran. Luna: Yeah, I've seen that. The euro's been hovering around one-point-sixteen against the dollar for weeks now. That's not a huge move, but it's steady — and given the headlines, you'd expect it to be weaker. Lucas: Right. And this isn't just a one-week blip. Look at the trade-weighted dollar index — it's at 119-point-three as of late May, down slightly from where it was a month ago. So the dollar is softening broadly, and the euro is one of the currencies benefiting. Luna: Let me ask the obvious question — why? The Eurozone is still dealing with sticky core inflation at three-point-three percent, the ECB is keeping rates high, and the war next door isn't exactly a vote of confidence. Lucas: It's a fair question. And the answer isn't about the Eurozone suddenly becoming a growth powerhouse — it's not. But there's a structural shift happening under the surface. The old narrative that the euro is always fragile, always the weaker cousin of the dollar, is starting to crack. Luna: Crack how? What's changed? Lucas: Well, one big factor is the current account. The Eurozone has run a consistent current account surplus for years — meaning it exports more than it imports, which creates natural demand for euros. Meanwhile, the US current account deficit has been widening again. That's dollar-negative in the long run. Luna: So it's not that Europe is booming — it's that the US is importing too much, and that flows through to currency markets. Lucas: Exactly. And there's another layer: Europe's pivot toward defense spending. Since the war in Ukraine and now the Iran conflict, European governments are committing to much larger defense budgets. That's a fiscal expansion that's partly domestic — it creates demand within the Eurozone, which supports the currency. Luna: Interesting. So even though the immediate geopolitical shock hurts confidence, the policy response — more spending, more domestic focus — actually shores up the euro over time. Lucas: Right. And this is where the ECB's job gets tricky. Core inflation is still at three-point-three percent, as of April. The Fed's preferred gauge is also around that level. So both central banks are in a similar spot — but the market is starting to price in more rate cuts from the Fed later this year, while the ECB is seen as more cautious. Luna: That relative rate differential matters. If the market thinks the Fed will cut sooner than the ECB, that puts downward pressure on the dollar and upward pressure on the euro. Lucas: Precisely. And look, I don't want to overstate this — the euro isn't suddenly the new safe haven. But it's gaining a kind of resilience that it didn't have five or ten years ago. The Eurozone has better fiscal coordination now, a more credible central bank, and a current account that's structurally in surplus. Luna: So if someone asks me 'what's the one number that explains the euro's strength?' — what do I point to? Lucas: I'd say the trade-weighted dollar index. It's dropped from around 120-point-five in early May to 119-point-three now. That's not a crash, but it's a clear trend. And when the dollar weakens broadly, the euro is the biggest beneficiary because it's the most traded counterpart. Luna: And it's not just against the dollar. The euro is also holding up against the yen and the yuan, which are both under pressure. Lucas: Right. The yen is at 159 per dollar — that's weak. The yuan is at 6-point-79 per dollar, also weak. So the euro is in a relatively strong position among major currencies, even if it's not shooting higher. Luna: And you know, quick honest thing — if walking through the economy with us has made something click for you, there's a small way to help keep this going. A handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds making this many episodes. Lucas: Yeah, it's a tiny group, but it makes a big difference. No ads, no sponsors — just listeners who find value in the conversation. Appreciate every single one. Luna: Alright, back to the euro. So if the currency is gaining resilience, what are the risks that could break that trend? Lucas: The biggest risk, I think, is energy inflation flaring up again. The Iran conflict has already pushed up gas prices — the average US household is paying about 450 dollars more per year on energy. Europe is even more exposed because it imports a lot of its natural gas. If energy costs spike again, that would hit the Eurozone economy hard and weaken the euro. Luna: But so far, that hasn't happened. The euro is holding up despite elevated energy prices. Lucas: That's the key point. The market is looking through the short-term energy shock and seeing a Eurozone that is more fiscally integrated, more domestically focused, and running a current account surplus. That's a different picture than the one we saw during the 2022 energy crisis. Luna: So the euro's strength is partly a vote of confidence in the structural changes Europe has made — even if they're incremental. Lucas: Yes. And it's also a reflection of the dollar's own challenges. The US is running large fiscal deficits, the current account deficit is widening, and there's political uncertainty around the election cycle. The dollar isn't collapsing, but it's no longer the only game in town. Luna: So what does this mean for investors? If the euro stays strong, does that hurt European exporters? Lucas: It does, at the margin. A stronger euro makes European goods more expensive abroad. But the impact is muted because a lot of Eurozone trade is intra-regional — about 60 percent of exports go to other Eurozone countries. So the currency move matters less than it would for, say, Japan. Luna: And for bond markets? A stronger euro could attract foreign capital into European bonds, pushing yields down. Lucas: That's already happening. We saw Southern European bonds rally earlier this year — spreads tightened. A stronger currency reinforces that trend because it reduces the risk premium for foreign investors. Luna: So the virtuous circle: stronger euro, lower bond yields, more fiscal space for governments to spend on defense and infrastructure. Lucas: Exactly. And that's the story that's been playing out quietly. It's not dramatic — no big headline number. But when you stack up the trade-weighted index, the current account, the fiscal shift, and the ECB's credibility, you get a euro that's more resilient than its reputation suggests. Luna: Alright, so next time someone says the euro is doomed, you've got the data to push back. Lucas: Exactly. It's not about being bullish on the euro — it's about being realistic about the structural changes that have happened. The old weakness narrative is due for an update.