Euro Recovery Doesn't Justify Stronger Currency, BNY Warns

According to BNY's Geoff Yu, the European recovery and inflation risks do not justify a stronger Euro (EUR) at this time. While industrial data is strong and fiscal support favors European assets, weak demand, European Central Bank (ECB) policy-error risk, and rich EUR valuation are weighing on the currency.

The recovery, while real, is not yet broad-based, as German services fell to 48.5, confidence weakened, and output-price inflation eased for a third month. Meanwhile, inventories, defense, and data-center investment are supporting industry in Europe.

Yu recommends using EUR-funded carry trades instead of outright EUR positioning, which is currently strong. He also notes that cross-border hedges sit nearly 60% below their one-year average, making investors underhedged on Eurozone assets. With the EUR rich and its rate differential against USD still negative, currency hedging should rise even if allocations to Europe continue.

In addition, Yu points out that the EUR remains overvalued, being nearly 2% above its one-year BIS REER average. While borrowing is relatively cheap in real terms, this may not last long.