Pulling dead weight through

EUROPE’S strongest man is Lithuanian this year. But its strongest economy is clearly German. The two have more in common than you think. Both are breaking records and are familiar with lugging around dead weight.

The German economy has been pumping out positive figures. Yesterday it announced that unemployment fell to a 19-year low and vacancies shot up by 15,000 since January. Rising Portuguese bond yields and periphery woes seem to have shrunk from the market’s attention. This has worked rather nicely for the euro. It has been edging upwards or holding steady for the last few weeks (see chart).

But traders know all good things come to an end. How much longer can they bank on Germany pulling the euro through?

GERMAN WILLING
Duncan Higgins of Caxton FX says: “It seems less of case of whether Germany is strong enough to pull Europe through, and more a case of whether Germany is willing.” The German public gave their chancellor’s party a kicking at the recent regional elections for her soft approach to their ailing neighbours.

Any measures proposing to redistribute German funds to shore up weaker economies will now be far trickier to push through. Market doubts about the whole of the Eurozone economy could send the euro tumbling.

MIDDLE EAST RISK
But until those big decisions edge closer, Michael Hewson of CMC Markets thinks the euro will be remain steady: “If the Middle East situation does not escalate any further, the euro will stay range bound against the dollar. It hasn’t been acting as the world’s safe haven just yet.”

Traders have so far been diversifying Middle Eastern risk through currency investments into Swiss francs and the Canadian dollar. This may change, believes Hewson, if the political situation worsens.

Simon Derrick, a managing director at the Bank of New York Mellon, has a similar view, but thinks that we are reliving last September’s euro story.

He explains: “The market totally ignored the fact that Ireland was heading towards a crisis. It wasn’t until it reached a sort of tipping point that the euro suffered.” Likewise, he rapidly rising Portuguese bond yields have sunk in importance in the media.

Euro traders should therefore expect the German strongman to deliver stability for a while longer. Only an escalation of the Middle East crisis and a German backlash at the March EU summit stand in his way.