Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / How European ETFs Are Being Hammered by a Strong Dollar
Transcript
- Lucas: European equity ETFs are having a rough week — and the culprit isn't really European at all. Luna: You're looking at the VGK, the EZU, the country-specific funds. They're all down pretty sharply in the last five trading days. Lucas: Right. The VGK, which tracks the broader developed European market, is down about 1.3 percent in five days. The EZU, the Eurozone-specific ETF, is off 2.4 percent. And the FEZ, another Eurozone fund, is down 2.1 percent. Luna: So the Eurozone is getting hit harder than the UK, where the EWU is actually flat over the same period. Lucas: Exactly. The UK ETF is up 0.2 percent. That divergence is a clue. The common thread here is the US dollar, which has been strengthening sharply. The trade-weighted dollar index hit 120.4 as of June 18, up from 119.39 just a week or two earlier. And the euro has slipped to 1.15 per dollar, down from 1.16. Luna: So a stronger dollar means weaker European stocks. But why is the correlation so tight right now? Lucas: There are two channels. First, a stronger dollar directly hurts European exporters — companies that earn revenue in dollars but report earnings in euros. When the dollar strengthens, those euro-denominated earnings shrink. Second, a rising dollar tends to pull capital out of international markets and back into US assets. That selling pressure shows up in ETF flows. Luna: And the selling isn't uniform. Look at the country ETFs. Italy's EWI is down 3 percent in five days. Germany's EWG is down 2.2 percent. France's EWQ is only down 0.7 percent. Lucas: That's a great catch. Italy is getting hammered, and it's not just the dollar. Italy has a larger exposure to energy imports, and the situation in the Strait of Hormuz remains fragile. You've got headlines about shipping rebounding after the us iran deal, but also the UN pausing evacuation plans after a vessel attack. Iran is warning ships it's 'unacceptable and dangerous' to transit without their approval. That uncertainty hits energy-dependent economies like Italy harder. Luna: So the dollar strength amplifies existing vulnerabilities. France, with more services exposure and less energy reliance, is relatively insulated. Lucas: Right. And the broader macro backdrop is worth noting. US core inflation — the Fed's preferred gauge — came in at 3.4 percent for May, the highest since October 2023. That keeps pressure on the Fed to maintain higher rates, which supports the dollar. Meanwhile, the Eurozone's real GDP growth is running at an annualized 2.1 percent, up from just 0.5 percent earlier. So the European economy is actually improving, but the currency headwind is overwhelming that narrative for equity investors. Luna: It's a frustrating dynamic for anyone holding European stocks right now. The underlying economy is getting better, but your ETF is down because of a factor you can't control. Lucas: And the ECB can't do much about it. If they cut rates to weaken the euro, they risk reigniting inflation. If they hold steady, the dollar keeps climbing. It's a classic policy squeeze. By the way, if walking through the economy with us has made something click, and you'd like to help keep this show ad-free and independent, you can support us at buy me a coffee dot com slash fexingo. No pressure, just if it's useful to you. Luna: Yeah, totally. That kind of direct support really does make a difference for shows like this. No ads, no sponsors — just the economics. Lucas: So where does that leave the European investor? If you think the dollar has further to run, the pain isn't over. But if you believe the Eurozone GDP growth will eventually translate into stronger corporate earnings, then the selloff might be creating an entry point. Luna: It's a classic valuation argument. European stocks are cheaper on a price to earnings basis than US stocks. But cheap can get cheaper if the dollar keeps rallying. Lucas: Exactly. And the ETF data reflects that uncertainty. The selling is broad — it's not just one sector or one country. Even the UK, which is flat this week, has been under pressure over the longer term. The key variable to watch is the euro-dollar exchange rate. If the euro stabilizes or rebounds, you could see a sharp reversal in these ETFs. Luna: What could cause the euro to stabilize? A more hawkish ECB? A surprise easing from the Fed? Lucas: Both are possible. The ECB has been cautious, but if inflation in the Eurozone stays sticky, they might hold rates higher for longer. That would support the euro. Alternatively, if US economic data softens, the Fed could signal rate cuts, which would weaken the dollar. But right now, the data points in the opposite direction — core inflation at 3.4 percent suggests the Fed is in no hurry. Luna: And then there's the geopolitical wildcard. Hormuz, Venezuela after the earthquakes, trade tensions. Any of those could shift currency flows quickly. Lucas: Absolutely. The dollar often strengthens during geopolitical uncertainty because it's a safe haven. So any escalation in the Middle East or other hotspots could actually make the problem worse for European ETFs. On the other hand, a durable peace deal that stabilizes energy markets could boost the euro by reducing the risk premium on European assets. Luna: So for the listener who's holding these ETFs, what's the takeaway? Should they be worried? Lucas: I'd say be aware, not alarmed. The selloff is real, but it's driven by a macro factor — the dollar — rather than a fundamental deterioration in European companies. If your time horizon is long, this could be a buying opportunity. But if you need to sell in the next six months, the currency risk is significant. The key is to watch the euro-dollar exchange rate as a leading indicator. Luna: And maybe diversify into UK or Swiss ETFs if you want to reduce euro exposure. The UK ETF is holding up better, and Switzerland isn't in the Eurozone. Lucas: That's a smart practical move. The EWU, the UK ETF, is essentially flat this week. And the Swiss Market Index isn't directly in these numbers, but historically it's less correlated with the euro. For now, the message is: understand what you own. If you're in a Eurozone ETF, you're making a bet not just on European companies but on the euro holding its ground against the dollar. Luna: And right now, that bet isn't paying off. But that can change quickly. Lucas: It can. Markets are forward-looking. If the dollar peaks and starts to decline, the reversal in European ETFs could be just as sharp as the selloff. That's the nature of currency-driven moves — they tend to snap back quickly when the catalyst shifts. We'll be watching the euro-dollar level closely in the weeks ahead.