The Euro – Worth Investing?

Introduction & Background:

The Euro is the official currency of the eurozone established in 1992 in the Maastricht Treaty. Currently, 19 out of 28 member states of the European Union utilize the Euro as their currency and it sits at 1 Euro to 1.13 U.S. dollars as of 30th November 2018.

In particular, the Euro has been the subject of many recent issues especially due to the debt crisis in Greece and a brewing spat between Italy and the requirements set out in the Maastricht Treaty on public debt. The lack of control over monetary policy in countries such as Greece led to severe austerity packages and a significant decline in Greek GDP. This has led to talk of reform for the Eurozone championed by Emmanuel Macron. Macron’s reforms include creating a post for finance minister within the EU, establishing a joint eurozone budget and creating an institution to oversee eurozone economic policy.

Also, in the midst of Brexit, the future of the European Union very well hangs in the balance, with the heads of state of both France and Germany recognizing the need to modify the European Union and the Eurozone if the bloc is to survive. As Angela Merkel puts it : “If we stand still, we will be pulverized.”

Key Drivers / Catalysts:

1. Brexit

A very promising factor for investing in the Euro comes in the form of the exit of the United Kingdom from the European Union. Although the United Kingdom was never in the eurozone, the foreign exchange markets have been highly responsive towards any change in the perceived successes of the negotiation. So far, the main effect of Brexit on the Euro has been to raise the relative value of the Euro against the pound which now regularly reaches between 0.87 pounds and 0.90 pounds. Before Brexit, the Euro sat around for 0.76 pounds.

Euro (EUR) to British pound sterling (GBP) from 1999 to 2017

In dealing with Britain, the European Union has remained steadfast behind its key negotiator Michel Barnier, acting unified as opposed to investors’ worries that the EU would be mired in uncertainty as other countries consider their own European exit. This has been conducive to its negotiating success, with every piece of news about Brexit seemingly raising the value of the Euro. As Theresa May faces one of the most difficult negotiating tasks, her cabinet has shown and threatened no-confidence in the Prime Minister with Sam Gyimah, the universities minister becoming the 7th minister to resign her government on Friday. He stated that the current deal would “cripple our interests for decades to come.” This augurs well for investing in the Euro now, as its value will likely rise in the future compared to the Pound.

2. Economic and Political Conditions of Member States

Currently, the Euro isn’t in its best form, as its value is a mirror of the weak economic state of the members of the Eurozone. The eurozone has just emerged from the debt crisis, having slowly reducing quantitative easing and discussing raising interest rates. GDP growth within the Eurozone has been sluggish. The overall average eurozone GDP growth rate is 0.6% in 2018. In addition, Italy’s populist government has submitted a budget that clearly breaks the budget deficit to GDP rule as stipulated in the Maastricht Treaty. In retaliatory measures, the European Commission threatened to impose sanctions on Italy including the suspension of EU funds and imposing fines.

Mario Draghi, President of the European Central Bank (ECB) since 2011 has faced difficulty in continuing his massive expansionary monetary policy, especially in Germany where the German public has been calling for QE policies to end. Negative rates are especially detrimental to the so called nation of savers. In addition, questions of the integrity of the Eurozone have been raised at the highest levels due to the debt crisis, where voters in productive nations such as Netherlands and Germany have been reluctant to continue sending stimulus packages / bailout funds to countries such as Greece who they see as having brought the crisis on themselves. All in all, the Eurozone faces contentious issues that threaten the future of the currency and will experience high volatility in the coming years.

Investment Thesis

Based off of current geopolitical trends within the Eurozone and the fundamental analysis conducted above, it would appear that there are no trends that would suggest a rise in value for the Euro. However, given the news of Brexit and the abysmal situation of the United Kingdom, one can probably bet that the euro will grow in value relative to the pound. The Euro has already been shown to rise in value based on the growing worries of the UK, and will do so in the future. Given that currency investments are mostly short-term, an investment in the Euro within the Brexit time period to 2019 could yield profitable returns and avoid any long term drop in the value of the Euro due to contentious issues within the Eurozone. It would seem that within the Brexit time period which largely lies between now to 2019, there will be a higher demand for the Euro leading to higher prices. A large number of firms are also largely looking to relocate headquarters to cities such as Frankfurt within the European Union to benefit from the customs market, and as such will generate large movements away from the British pound (selling) and buying Euros.

Risk

An inherent risk lies in the assumptions that Brexit will continue to go poorly for the Britons and that Brexit news will continue to dominate investors’ fears. If Brexit turns out to strengthen Britain’s position in the wake of leaving the European Union, it is likely that the Euro will fall in value relative to the pound as the economic position of the UK will be strengthened, portending future exits from the European Union. In addition, if investors consider issues such as Eurozone reform to be of more importance than news on Brexit, it is likely that many will consider releasing their holdings of Euro and invest in a more stable currency elsewhere. Thus, sentiments regarding Brexit are extremely important in the future regarding any rise or fall in value of the Euro