Being the dollar’s main competitor, the euro does not have good press.
Ill-informed financial market analysts continue to question the euro’s finality. They don’t understand that the European currency is the irreversible legal tender of an economic and political union weaved around a deeply integrated French-German policy making.
Those analysts are now recommending developing economies’ (including China’s) assets as alternatives to Wall Street offerings – instead of highlighting a good earnings outlook, ample liquidity, regulatory stability and investor protection in euro area markets.
Reaching for developing world’s assets ignores the possibility that worsening growth prospects and rising interest rates in the U.S. will adversely affect that dollarized universe of smaller economies that depend on external demand and cheap international credit flows.
A quick preview of the likely things to come can be seen in dollar and euro asset prices since the latest economic policy announcement in the U.S. and the euro area.
Over the last month, for example, the Dow Jones lost 4.6% from the same period of 2021. During the same interval, the Euro Stoxx 50 declined 3.9%.
Euro area has more room to support growth
It’s too early, of course, to talk about any major and sustained decoupling of trans-Atlantic equity markets, but it’s not too far-fetched to consider those price moves as reflections of important monetary policy differences.
The U.S. Federal Reserve (Fed) wants to reassure financial markets about its determination to stop and reverse America’s accelerating price inflation, while the European Central Bank (ECB) maintains a view of euro area’s relatively modest cost and price pressures in an environment of a large labor market slack and sluggish economic growth.
Bond markets are closely reflecting those policy lines.
In the U.S., money market rates are rising as a prelude to an announced interest rate increase, while the long end of the yield curve suggests a growth recession.
Things are radically different in the euro area. Taking the German interest rate structure as a point of reference, bond markets agree with the ECB’s expectations of lackluster growth, high unemployment and reversing price pressures. As a result of that, the euro area short-term interest rate remains firmly anchored at -0.50%, while the 10-year bond yields -0.05%. One must go to a 30-year bond to find a puny positive return of only 0.23%.
Those very different yield curves indicate diverging policy objectives pursued by the U.S. and euro area monetary authorities.
The Fed has the impossible mission of stopping and reversing an accelerating inflation in a way that would avoid a growth recession at a time the U.S. is facing an all-important mid-term Congressional election (November 2022) -- followed by an immediate entry into a presidential contest that will last until November 2024.
Euro area wants a “win-win cooperation”
By contrast, the euro area’s core inflation rate (consumer prices minus energy costs) of 2.5% will make it possible -- and necessary -- for the ECB to calibrate its credit stance in order to support growth and employment creation.
Equally important is the external demand facing those two economic systems.
The U.S. is currently on a quasi-war footing with Russia, China, Iran and North Korea, with enduring hostilities in the Middle East and parts of North Africa. That will be a drag on America’s resources, while a large part of its domestic demand will continue to leak out in growing trade deficits with China and the EU.
The euro area is not sharing those concerns. Most European countries don’t seem ready to follow the U.S. bellicose posture. Business with China is actively pursued by America’s EU allies. Poland is even sending its president to attend China’s Winter Olympics.
There are daily news of EU countries showing keen interest in trade with China. Germany, for example, is telling a small EU country to stop interfering in China-Taiwan relations for fear of creating problems for EU-China ties and German exports. France is also reassuring Beijing that during its current EU rotating presidency Paris will promote “a win-win cooperative relationship between EU and China.”
Similar developments are also apparent in EU relations with Russia. France, Germany and Hungary don’t want to be shunted aside in ongoing U.S.-Russia talks; they want to build their own EU security architecture -- while keeping open the flows of trade, finance and energy supplies with Russia.
The upshot is that in the months and years ahead, the euro area will have a number of attractive advantages: (1) a broadly accommodative monetary policy, (2) a reinforced and expanding monetary union, (3) more integrated fiscal policies, (4) sustained efforts to lower public debts and deficits, (5) large trade surpluses and (6) more constructive ties with its Eurasian neighbors.
All that means that the euro area assets will continue to offer good alternatives to dollar-based investors.