Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / Why Eurozone Banks Are Exposed to a US Slowdown
Transcript
- Lucas: So the US jobs report on Friday was a genuine surprise — 23,000 jobs lost in July, against expectations of growth. And the numbers that matter for Europe, the trade-weighted dollar is drifting lower, down to 119.1 from 119.5 a week ago. But here's the twist: eurozone stocks have barely flinched. Luna: Right, the Vanguard FTSE Europe ETF is up half a percent over five days. That's not exactly panic. Are we looking at a decoupling story, or just a delayed reaction? Lucas: I think it's more nuanced than that. We've been talking for weeks about how the eurozone is holding up despite trade tensions and the Rhine drought. But if the US labor market is genuinely softening, the Fed might cut rates sooner than we thought. And that changes the calculus for every European asset class. Luna: Before we get into the weeds — and I know I say this more than I should — if unpacking this with us has made something click for you, we'd love it if you bought us a coffee. It's buy me a coffee dot com slash fexingo. Keeps the show running ad-free. Lucas: Absolutely. No pressure, but it genuinely helps us keep doing this. Now, let's talk about the dollar. The euro is holding around 1.16, pretty flat over the past week. But the yen strengthened — 157.5 per dollar, down from 158.5. That's a classic risk-off move. Luna: So the dollar is weakening broadly, but the euro isn't really participating. That's interesting. What does that tell us about the eurozone's prospects? Lucas: It tells me the market sees the eurozone as less sensitive to Fed policy than, say, Japan. But that doesn't mean insulated. Look at the German ETF — it's up 0.8 percent over five days, while the UK is flat. There's a divergence within Europe itself. Luna: Germany outperforming the UK — is that about exporters benefiting from a weaker dollar, or something else? Lucas: Partly the weaker dollar, yes. A softer dollar makes German goods cheaper in US markets, which matters for auto and machinery exporters. But there's also a domestic story: German fiscal spending has been creeping up, and that's supporting demand. Meanwhile, the UK is still dealing with its own inflation hangover. Luna: And Spain? The iShares MSCI Spain ETF is up 0.8 percent too. That's been the star performer for a while now. Lucas: Spain's story is different — it's more about services and tourism, less about exports. The weaker dollar actually hurts a bit because it makes European holidays more expensive for Americans, but the domestic recovery is still strong. And Spanish banks are in better shape than their German counterparts. Luna: Ah, the banks. We've talked about the unrealized bond losses they're sitting on. How does a Fed cut play into that? Lucas: That's the crux. European banks have been loading up on government bonds and holding them to maturity. If the Fed cuts and the ECB follows, those bond prices go up, which would actually ease some of those unrealized losses. But it's not that simple — the ECB has been slow to cut because of inflation concerns, and the data this week could change that. Luna: The inflation report on Wednesday, right? What are the expectations? Lucas: Most economists see headline CPI cooling a bit, but core inflation is sticky. The market is pricing in a high chance of a cut in September, but that could unravel if the number comes in hot. And that's what European investors are watching — because the ECB tends to follow the Fed's lead, even if they hate to admit it. Luna: So the eurozone's fate is tied to a US inflation print. That seems like a lot of pressure on one report. Lucas: It is. But that's the transatlantic reality. The trade-weighted dollar index has been drifting down all summer, and that's a signal that global liquidity is loosening. That's generally good for risk assets, including European equities. But if the Fed surprises to the hawkish side, that could reverse quickly. Luna: And what about the money market funds? We saw deposits fleeing bank accounts into those funds earlier this year. If rates are about to peak, does that flow reverse? Lucas: Good question. The flow into money market funds was driven by the gap between deposit rates and the yields on short-term government paper. If the ECB cuts, that gap narrows, and we might see some money trickle back into bank deposits. But it's a slow process — and banks are still hoarding cash because they're worried about credit risk. Luna: So even if a Fed cut helps bond prices, it doesn't necessarily mean banks will start lending more. Lucas: Exactly. The bank profitability story is more about the yield curve than the level of rates. A steeper curve helps them borrow short and lend long. Right now, the curve is still pretty flat, so banks aren't exactly rushing to extend credit. Luna: But the equity market seems to be looking past that. The Euro STOXX 50 has been grinding higher. Is that justified? Lucas: I'd say it's cautiously optimistic. If the US avoids a hard landing and the Fed cuts a few times, that's a decent environment for European earnings. But the risk is that the US jobs report is the canary in the coal mine — if we get another negative print, that changes the narrative from 'soft landing' to 'recession', and Europe won't be spared. Luna: So the next few weeks are critical. What are you watching specifically? Lucas: Three things. First, the inflation report on Wednesday — any upside surprise would shake the rate-cut expectations. Second, German producer prices, which are a leading indicator for the eurozone. And third, the euro-dollar exchange rate. If the euro breaks above 1.17, that's a signal that the market is betting on a more hawkish ECB, which could pressure exporters. Luna: And if it drops below 1.15? Lucas: That would suggest the market thinks the ECB will have to cut more aggressively than the Fed — which would be a sign of divergence, and probably not a good one for European risk assets. Luna: Given all this, what's the one thing you'd tell a listener who's thinking about adding European exposure right now? Lucas: I'd say don't chase the recent rally. The performance over the last five days has been nice, but the macro picture is still fragile. Wait for the inflation report and see how the dollar reacts. If the dollar stays weak and the euro holds steady, there might be more room for eurozone stocks. But if the dollar reverses, that could be a red flag. Luna: So the simple takeaway: watch the dollar, watch the data, and don't assume Europe can decouple completely. Lucas: Right. The eurozone has its own strengths — Spain is booming, Germany is stabilizing — but the Fed still holds the remote. And the next few days could tell us a lot about which way the wind is blowing.