How the Euro Became Decoupled From the Price of Assets

In recent weeks, rhetoric seems to have politicized the valuation of currencies. This is especially true in Europe, which has experienced a notable divergence between the performance of the bond market and that of the euro. In a year of elections in the Netherlands, France and Germany that could usher in a large sweep of populist parties to parliaments, the decoupling between the euro and European asset valuations has several implications for investors.

The first notable difference is between the euro spot exchange rate and peripheral bond spreads. During the European debt crisis from 2010 to 2012, the relationship between the decline of the euro and widening bond spreads was always very close. This was the result of capital outflows from foreign investors who exited European bonds out of fear of “redenomination risk,” as well as the conversion of euro currency back to local currency (such as Italian lira or Greek drachma).