Key Takeaways

  • Investment “reflation trades” favor European stocks and the euro over US stocks and the dollar.
  • Italy’s new Prime Minister Mario Draghi is faced with high expectations for Italy and Europe.
  • EU recovery fund reduces euro “existential risk.”

Spot (mid-market) rate = $1.2080 (8:30am, February 18, 2021)1

The euro is underperforming, yet stable. The euro has underperformed many other G-10 currencies in 2021, but market volatility (risk) for the EUR/USD currency pair has dropped to pre-pandemic levels and is amongst the lowest of all foreign currencies versus the dollar.

Several themes are currently driving a stronger EUR:

“Reflation” favors European stocks/EUR over US/USD

Investors increasingly see global reflation for 2021 and beyond, characterized by global economic growth, steepening yield curves, and overall “risk-on” sentiment. In this environment, so-called “reflation trades” include pro-cyclical stocks (undervalued foreign stocks more attractive than overvalued US stocks), commodities, and foreign currencies. Global investors have been gradually becoming bullish European stocks and the euro since last summer, and at the same time large currency speculators have built up the biggest net long position in the euro since early 2018.2

Italy’s new prime minister

Last Saturday, Mario Draghi was sworn in to serve as Prime Minister of Italy, Europe’s third largest economy. Highly respected both home and abroad, Draghi has been nicknamed “Super Mario” for his role in saving the euro. Investors have high expectations that he will move swiftly to lift Italy out of its worst recession since WWII, with a plan to: 1) vanquish Covid-19; 2) enact much-needed political and economic reforms; and 3) organize a sensible spending program for the €290bn that Italy will receive from the EU post-Covid recovery fund.3 When Germany’s Angela Merkel departs later this year, Draghi will likely fill her shoes as Europe’s unofficial leader and figurehead.

An expected Eurozone (EZ) economic recovery

Although the eurozone economy contracted in Q4 by 0.7% QoQ, analysts expect an economic recovery in 2021 fueled by massive government fiscal stimulus/relief and ECB monetary/QE stimulus. Nevertheless, Covid-19 threatens to delay European recovery as further lockdowns and restrictions take place that may lead to another GDP contraction in Q1 or Q2.4 Recovery is fully expected in H2, partially fueled by the recently signed and potentially impactful EU/China investment deal, which will govern future bilateral investment.

EU recovery fund reduces euro “existential risk”

In one important way, the pandemic crisis has strengthened the euro. The EU’s €750bn recovery fund helps mend what many thought to be a significant flaw of the single currency: a monetary union without a fiscal union. The “risk premium” linked to European assets should head lower coming out of this crisis.

Final comments

The euro has benefited from the ongoing “reflation” theme currently driving global investments. The trifecta of US elections, vaccine availability and a Brexit agreement eliminated a great amount of uncertainty, elevating demand for risky assets and putting the dollar on the defensive. However, in Q1 (and possibly into Q2), the US dollar is pausing in its decline, and in some cases, regaining ground against many currencies, including the euro. The good news -- a weakening euro will provide opportunities for firms to buy them at more attractive levels. Talk to your SVB currency advisor where those levels might be.

Please feel free to reach out to your SVB Currency Advisor for a deeper discussion about FX, what impact it may have on your firm, and ways to mitigate risk.


1,2 Bloomberg

3 “Draghi: Call of duty for Italy’s ‘Super Mario’. BBC NEWS. February 12, 2021

4 “European Central Bank stimulus on track as economy struggles.” Federal News Network. January 21, 2021

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Written by
Scott Petruska, CFA
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