Despite a weakening Euro (EUR), the Eurozone economy continues to show signs of recovery. Geoff Yu of BNY Mellon highlights that manufacturing PMIs and business surveys across Germany and Europe indicate growing demand. The Eurozone manufacturing PMI held steady at a four-year high in September, with factory output expanding at its fastest pace in nearly five years. New orders and backlogs are also rising, suggesting a strengthening demand.
The Euro has declined by 1.4% in its nominal effective exchange rate since the beginning of September. This decline began before concerns about France’s fiscal position emerged, suggesting that the Euro was overvalued and interest-rate expectations were stretched. Limited short positioning and hedging left room for adjustment, contributing to the currency’s weakness.
European Central Bank (ECB) President Christine Lagarde has acknowledged that current front-end interest-rate levels would “slow growth.” Recent global bond market moves are tightening financial conditions further, a point echoed by ECB Chief Economist Philip Lane. The French government has announced fiscal consolidation measures, with legislation expected to pass in the fourth quarter. Consequently, expectations for year-end ECB rates have fallen below pre-decision levels, adding to the Euro’s weakness.
Unlike the 2011-2012 period, there is no spillover from OAT volatility into FX markets. Ten-day realized EUR/USD volatility remains within its range since May, even as realized volatility in OAT futures has spiked. The ECB’s retreat from firm rate guidance has helped dampen volatility.