Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / Why the Euro Is Falling as European Stocks Rally
Transcript
- Lucas: So European stocks are having a decent late spring here — the VGK ETF, which tracks the broad continent, is up about one and a half percent over the last five trading days. The eurozone-specific EZU is up even more, nearly two percent. But if you look at the currency underneath all that, the euro is actually losing ground against the dollar. Luna: That's the piece that feels weird to me. Stocks up, currency down — normally you'd expect them to move together, right? Lucas: Right, normally a stronger economy lifts both. But we're in a pretty specific moment. The euro dropped from about one point one seven dollars to one point one six just in the last week or so. And the trade-weighted dollar index hit a hundred and nineteen point three — that's the highest in years. So the dollar is just crushing everything. Luna: Is that just the Iran war driving safe-haven flows? Because that's the headline I keep seeing. Lucas: It's a big part of it. The Iran conflict has rattled energy markets — we saw that story about Putin and Xi reviving a stalled Russian gas pipeline. Europe is especially exposed because it imports a huge share of its energy. So when geopolitical risk spikes, capital tends to flee into US assets. The dollar benefits, and the euro takes the hit. Luna: But if European stocks are rallying, that suggests some confidence is still there. Who's buying? Lucas: That's the interesting part. A lot of the buying is coming from domestic and regional investors, not foreigners. European pension funds, insurance companies, retail — they're rotating back into their own markets after a rough couple of years. But the marginal dollar, so to speak, is flowing out of the euro and into US Treasuries or dollar cash. Luna: So local money stays, global money leaves. That creates the divergence. Lucas: Exactly. And it's reinforced by the ECB's posture. They're not going to hike rates into this environment — the economy is still fragile, and inflation, while sticky, is largely driven by energy costs that are outside their control. So real interest rate differentials are widening in favor of the US. Luna: That makes sense. And it's not just the euro — the yen and the yuan are also weakening against the dollar. The yen is at a hundred and fifty-eight point seven per dollar, yuan at six point eight one. Lucas: Yeah, the dollar is strong against basically everything. But the euro story has this extra layer because of the energy channel. Europe's nominal GDP is still over thirty-one trillion dollars, and real GDP growth just ticked up to two percent annualised from half a percent. So the economy is improving — but the currency is saying something different. Luna: Is that partly because the improvement is uneven? Southern Europe is doing better, Germany is still struggling? Lucas: Exactly right. The country-level ETFs tell the story. Germany's EWG is up one point three percent over five days, but Italy's EWI is only up zero point three, Spain's EWP is flat. The growth divergence within the eurozone is still real. And that makes it harder for the ECB to have a single policy that works for everyone. Luna: But here's the thing that I find really interesting: Southern European bonds are suddenly being treated as safe havens. We did an episode on that a while back, and it seems to be holding. Lucas: It is. Italian and Spanish government bond yields have converged toward German bunds in a way that would have been unthinkable ten years ago. That's partly because the ECB's backstop mechanisms like the Transmission Protection Instrument have worked, and partly because investors are starved for yield in a world where German bunds are still near zero. So they take the extra few basis points from Italy and call it safe enough. Luna: So you have this weird market where European stocks are up, the euro is down, bonds are converging, and the common thread is the dollar strength and the energy shock. Lucas: That's the frame. And the question is: does it persist? If the Iran situation de-escalates, energy prices could drop, the euro could rebound, and the stock rally could broaden. But if it drags on, the dollar stays strong, the euro stays weak, and European equities become a kind of 'cheap currency play' for international investors. Luna: Which actually could be a tailwind for exports, at least for the big German manufacturers. Lucas: It could. A weaker euro makes European goods cheaper globally. But the problem is that many of those exports — machinery, chemicals, cars — are energy-intensive to produce. So the input cost goes up at the same time the currency helps on the revenue side. It's not a clean win. Luna: Right. And consumer sentiment in the US just hit a fresh record low in May, according to the Michigan survey, because of inflation fears tied to the war. That's going to hit demand for European exports too. Lucas: Exactly. The US consumer is the engine of global demand. If they pull back, Europe feels it. So the stock rally we're seeing might be a bit of a head fake — or at least it's fragile. The real test will be when second-quarter earnings start coming in. Luna: Yeah. So for someone holding European equities right now, what's the main thing to watch? Lucas: Two things. One: the euro-dollar exchange rate. If the euro drops below one point one five, that's a signal that capital flight is accelerating. Two: energy prices — especially natural gas in Europe. If they spike again, the rally in stocks will reverse. If they stabilize, the rally has legs. Luna: And the ECB? Anything they can do to support the currency? Lucas: They could signal a rate hike, but that would choke off the recovery in places like Spain and Italy. They could also use their forex intervention tools, but they've been reluctant to do that since the pandemic. I think they'll just talk tough and let the market play out. Luna: So basically, the euro is caught between a rock and a hard place. Lucas: Exactly. And if you're listening to this show regularly, you're probably tracking these cross-currents yourself. It's a lot to follow — which is exactly why we do this. Luna: Speaking of which — a couple of dollars a month is genuinely what keeps these episodes coming. If walking through the economy with us has made something click, you can support the show at buy me a coffee dot com slash fexingo. It's a small way to keep this ad-free and focused. Lucas: Yeah, and it really does make a difference. We hear from listeners who say it helps them make sense of their own portfolios or just understand the news better. So if that's you, consider it. Now, back to the markets — one more data point I want to flag. Luna: Go ahead. Lucas: The UK's trade deal with Gulf states — that's going to be interesting for the pound, but also for eurozone exporters who compete with British firms in the Middle East. If the UK gets preferential access, European companies might lose market share. That's a micro story that could add to the macro pressure. Luna: So another headwind. But also an opportunity for European firms to push for their own trade deals. Lucas: Right. The EU is already in talks with several Gulf countries. But those negotiations take years. In the short run, the UK has a first-mover advantage. And that's a reminder that in this environment, currency movements are just one piece of a much bigger puzzle. Luna: Alright, Lucas. Good framework. I think the listeners have a clear lens to watch the next few weeks. Lucas: Thanks, Luna. That's it for today. We'll keep tracking it.