David Brown

Macroscope | Oversold euro has better days ahead as US dollar strength starts to unwind

Global currency managers are reassessing their positions on the euro as sentiment turns against the US dollar and investors look for better currency bets

As sentiment improves, portfolio reweighting should add more momentum to the euro’s rally and create better times for Europe’s shared currency

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People wait at a currency exchange office as pedestrians walk at Omonia square in Athens, Greece, on July 13. The euro appears set for a comeback on the global exchanges only a few months after falling to parity with the US dollar for the first time in nearly 20 years. Photo: AP

David Brown

Published: 10:00pm, 28 Nov 2022

The dominant US dollar will be a tough act to follow. The strong dollar trade continues to unravel as the US Federal Reserve winds down its aggressive interest rate campaign against inflation and investors ponder the possibility of an early US rate easing in 2023.

The quandary for investors now is choosing which is the best currency bet instead. Has all the bad news been factored into the euro, making it a prime time for investors to buy again? The European Central Bank (ECB) is still sabre-rattling over inflation, and the ultra-hawkish German Bundesbank finally seems to be getting its way in curbing excessive price rise risks.

US-euro government bond yield gaps are starting to narrow, most of the shock of the Ukraine war is already factored in and safe-haven US dollar demand is losing its appeal. Global currency managers will be reassessing the need for rotating overweight US dollar holdings into longer euro positions. Will 2023 be the year the euro comes back into favour?

The euro is already back on the road to recovery, bouncing back from a dip below parity versus the US dollar in September, subsequently rising 8 per cent as the rampant US currency has eased. The war in Ukraine has not helped euro perceptions since hostilities broke out in February, as investors have fretted over the risks of the conflict spilling over into the rest of Europe.

But with the war grinding to a winter stalemate and with suggestions of peace moves circulating, it’s no surprise investors believe the euro may be oversold and due for a sustained recovery in the coming months. But it has to be conditional on regional risks not flaring up again.

There is a growing sense that risk aversion is coming off the boil and market confidence is building up again. Stock markets remain in a reasonably bullish mood, with fear factor measures such as the CBOE volatility index moderating in recent weeks.

Women from Ukraine dressed up as angels collect donations for Ukrainian children at the Christmas market in front of Charlottenburg Palace in Berlin, Germany, on November 24. With the war grinding to a winter stalemate, investors are coming round to the idea that the euro may be due for a recovery in the coming months. Photo: Reuters