Herr Muecke Loving Euros Proving Reports of Demise Exaggerated

For Raimund Muecke, the euro’s 17 percent surge against the dollar over the past five months signals a return to the days when a thriving Germany and an appreciating deutsche mark meant a robust Europe.

“A strong euro is good for Germany,” said Muecke, 63, who along with his wife was babysitting his grandson last week at a farmer’s market on the Konstablerwache in Frankfurt. “If Germany is doing well, others do well too.”

Foreign-exchange traders agree. The euro rose above $1.42 last week from a four-year low of $1.1877 on June 7 as investors discounted the chance that fiscal crises from Ireland to Greece will lead to defaults, fracturing the currency. Like the mark before it, the euro is reflecting Germany’s export-fueled growth. Goldman Sachs Group Inc. predicts the euro will strengthen to $1.55 in a year. The currency was at $1.3912 today.

The appreciation is signaling confidence the $1 trillion European Union financial backstop created in May will limit damage from the budget strains roiling nations on the region’s periphery. The shared currency rose last week even as Irish bond yields climbed to records relative to German bunds.

“Earlier this year, the currency market was worried that the euro zone would not survive politically, but now if there is a fire in one of your rooms, it no longer means that the whole house will go up in flames,” said Thomas Stolper, an economist at Goldman Sachs in London.

Default Swaps

While an index of credit-default swaps measuring the cost of protecting Greek, Irish, Portuguese and Spanish government bonds from nonpayment more than doubled since May 12, just after the EU and International Monetary Fund rescue package was implemented, the euro strengthened 11 percent to the dollar. The swaps pay buyers face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

Irish 10-year bond yields soared to 7.72 percent on Nov. 5 and reached a record 534 basis points, or 5.34 percentage points, above benchmark bunds, according to Bloomberg data, on concern that the cost of bailing out the nation’s banks will overwhelm government finances.

Should Ireland be unable to sell debt next year, it would be able to borrow from the European Financial Stability Facility, or EFSF, to meet payments to bondholders and fund its deficit.

Yield Spreads

The Greek-German yield difference widened last week to more than 900 basis points for the first time since Sept. 21. Greek Prime Minister George Papandreou said local elections yesterday would be a key test of support for his government as it grapples with a crippling budget deficit. The Portuguese-German spread also expanded, reaching 400 basis points last week for the first time since Oct. 13.

“It’s only when the big countries like Spain get involved that it’s relevant for euro-dollar,” said Bilal Hafeez, global head of foreign-exchange strategy at Deutsche Bank AG in London, who sees the euro rising to as high as $1.50 over the next three-to-six months. Greece, Ireland and Portugal are less consequential because “in GDP terms they’re tiny, they’re like Idaho. Right now it’s the Germanic aspects of the euro area that are driving” the currency, he said.

Ireland’s gross domestic product accounted for 1.8 percent of the euro-region’s 9 trillion-euro ($12.6 trillion) economy last year, with Portugal at 1.9 percent and Greece at about 2.6 percent. Spain represented 12 percent, with German output amounting to 27 percent.

Export Strength

Germany’s exports have rebounded from a four-year low in May 2009 as a drop in U.S. demand was countered by an increase from Asia. Sales to Asia this year through August were more than twice those to America, compared with 1.4 times for all of 2009, according to the Federal Statistics Office in Wiesbaden.

Munich-based Bayerische Motoren Werke AG, the world’s top maker of luxury vehicles, boosted its 2010 profit forecast on Nov. 3 after posting an 11-fold jump in net income. BASF SE, the biggest chemical maker, will generate sales and earnings next year that surpassed the record levels predicted for 2010, buoyed by growth in China, Martin Brudermueller, a board member of the Ludwigshafen-based company, said Oct. 29.

German GDP grew for five consecutive quarters since the nation emerged from recession in the second quarter of 2009, including a 2.2 percent jump in the three months through June. The euro area expanded 1 percent in the period. The U.S. grew at a 1.7 percent annual rate in the second quarter and a 2 percent pace in the third quarter.

‘Massive Impact’

“What strikes me is just how damn strong the data is,” said Tim Bond, a strategist in London at Odey Asset Management LLP, which manages about $6 billion. “If you have strong growth in Germany, that has a massive impact on places like Greece.”

For Muecke, a pensioner visiting the Frankfurt market from the suburb of Harheim, the euro today reminds him of the period before the currency was created in 1999, and the mark was the proxy for Europe.

“It looks like the economy is booming again, you can see that in the auto industry,” he said. “Things are looking up. We’re pulling the others along.”

Signs are emerging the euro may be peaking as traders shift their focus to the region’s fiscal challenges after pushing down the dollar in anticipation of last week’s announcement by the Federal Reserve that it will buy $600 billion of bonds to boost the economy in a move known as quantitative easing, said Lee Hardman, a currency strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. in London.

Dollar Bets

Bets the dollar will weaken against a basket of currencies including the euro, the yen and the pound held last week at about the most since at least 2003, according to data from the Commodity Futures Trading Commission in Washington. The difference in the number of wagers by hedge funds and other large speculators on a decline in the dollar compared with bets on an advance, so-called net shorts, was 288,677, data on Nov. 5 showed, compared with the average of 88,620 since 2003.

The euro hasn’t gained as much against other currencies, rising 2.1 percent since June 7, as measured by Bloomberg Correlation-Weighted Currency Indexes.

“Tensions in Europe are snowballing and they’re going to continue to build now that the Fed is out of the way,” Hardman said. “The Fed-QE story is a factor that will be a weight on the dollar, but given the scale of the selloff we think a lot of that bad news is now in the price.”

The median estimate of about 40 strategists surveyed by Bloomberg is for the euro to weaken to $1.39 by the end of the year, and to $1.35 by mid-2011.

Deutsche Mark

The euro is almost as strong as the mark was at its peak in March 1995, when it touched 1.3456 per dollar. A synthetic mark based on the euro’s value was 1.3939 on Nov. 5. The euro reached the equivalent of 1.2198 marks per dollar in July 2008, the strongest since the 16-nation currency was created in 1999.

Diverging monetary policies may also favor Europe’s currency. While the Fed adds more stimulus to the U.S. economy, Jean-Claude Trichet, president of the Frankfurt-based European Central Bank, signaled on Nov. 4 that policy makers intend to stick to their plan of removing such measures.

The rate at which banks in Europe say they lend to each other in euros for 12 months was 78.8 basis points more last week than the equivalent-maturity dollar London interbank offered rate, or Libor. That’s the most since January 2009 and up from 3.8 basis points in May.

“For people looking to position for a weak dollar, the euro is an attractive way to do it because you don’t have a central bank standing in your way,” said Ronald Leven, an executive director and currency strategist at Morgan Stanley in New York.

Trade Advantage

Goldman Sachs’s Stolper said the euro will climb against the dollar next year because of the region’s superior terms of trade relative to the U.S., which has posted a current-account deficit each year since 1991. Stolper forecasts the euro will rise to $1.50 in six months and to $1.55 in a year.

The U.S. current-account deficit, the broadest measure of trade, widened 13 percent in the second quarter to $123 billion, and has averaged about $140 billion from 2000, according to data compiled by Bloomberg. The euro region posted a deficit of about 24 billion euros in the three months ended June 30.

To contact the reporters on this story: Matthew Brown in London at mbrown42@bloomberg.net; Paul Dobson in London at pdobson2@bloomberg.net.

To contact the editors responsible for this story: Daniel Tilles at dtilles@bloomberg.net.

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