4 - Kicking up a Fusilli
Eurozone breakup fears re-emerge, and this time it’s not the UK .
Consensus view: Despite the devastating effects of the Covid pandemic, the alliance of the European Union seems to be stronger than ever. It was bolstered immeasurably by the agreement between richer member states and former stimulus hawks such as Germany to issue collective debt in the throes of the first wave of the Coronavirus. Investors interpreted this as a clarion call for Continental unity and solidarity. As we enter 2021, the Eurozone no longer appears moribund, and the Euro is again gaining credibility as international payment currency. This single currency had a smashing 2020, up over 8% versus the US dollar.
What the market is not pricing in: Good intentions tend to fizzle in the labyrinth of Eurozone bureaucracy. The impact of the pandemic on public health and economies diverges significantly, with the poorer South being hit much harder than the richer North. Despite a generous stimulus package being agreed, money remains to be slow to flow to the states – and the people – who need it most. This will add rocket fuel to restive right-wing populism in hard-hit countries like Italy. Moreover, far from deterring Eurosceptics, Brexit negotiations might provide a blueprint to navigating legal challenges when leaving the bloc for others.
Potential market reaction: Uncertainty around the stability of the EU and its trade environment could prove to undermine Eurozone equity prices, and the EUR/USD pair drops to par as fears mount yet again about the future of the union. The euro loses credibility as payment and reserve currency, and large capital flows into USD-denominated bonds further depress yields in the US and prop up the dollar. US equities and bonds benefit from lower rates driving down discount rates.
Our positioning: When it comes to our international holdings (i.e. ex-UK), our US equity exposure significantly outweighs Eurozone assets. Indeed, should US Dollar strength occur broadly, it has the net effect of raising the value of our non-Sterling denominated assets, providing tailwind in global strategies.
Chart 4: EURO/USD Mid Spot Exchange Rate
2000 - November 2020
Source: Kleinwort Hambros, Bloomberg
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