Listen: euro shrugs off German coalition worries
The German chancellor's coalition problems had only a fleeting impact on the euro, as investors were more interested in rising business confidence in the eurozone. George Papamarkakis of North Asset Management tells Roger Blitz why the single currency is in good shape and why the Swedish krona is also heading higher despite a big fall this week
Presented by Roger Blitz and produced by Fiona Symon
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Welcome to Hard Currency, the podcast of the Financial Times on the foreign exchange market. I'm Roger Blitz, and Europe was the main battleground for the markets this week, tested by the collapse of coalition talks in Germany, which raised questions about the future of Chancellor Angela Merkel. While the Swedish krona was heavily sold off on concerns about the housing market and inflation, and the Turkish lira came under pressure, not for the first time, from further concerns about the independence of the country's central bank.
With me to discuss the week's events is George Papamarkakis, co-founder and managing partner of North Assent Management. George, welcome. Angela Merkel on Monday, we had a big sell-off in the euro in Asia. When Europe woke up they decided, no, we don't think that's the story, and suddenly the euro is back on track. What did you make of the market reaction to that story?
I think that was a fair assessment in terms of the way how Europe reacted. I think in the short term, the coalition breakdown, if you like, is not that significant, in the sense that what we've just realised over the last couple of days is that there are going to be further talks. And there's still a high probability that we're going to get some type of a coalition, either back with the Jamaica coalition or, potentially, a minority government supported by the SPD. So I think, in the short term, in terms of significant euro weakness, it's valid not to have any concerns.
And not for the first time, the market was far more interested in data. They had some strong survey numbers out. And at the same time, we've had certain worries about the US. The minutes of the Fed meeting were a little bit more dovish on the idea of 2018 hikes, which kind of begs the question, are we about to enter another big euro rally?
It is true that the European data has really continued to surprise on the upside. I mean, today's PMI was at a 6 and 1/2 year high. We were expecting it to soften like it did last month. And that is a legitimate reason to continue to be optimistic about Europe in the near term. One would expect that a lot of the impulse that we saw, which started really at the beginning of the year, should start to fade.
So the impulse behind--
Behind effectively continued loose monetary policy. The positive base effects that we've gotten, really, in a lot of the data, that should all start to subside entering into Q1. So we think we're-- but we did say this earlier-- we do think we've reached a high point in terms of European growth, and we'd expect it to soften.
That, I think, is going to make it a little bit more difficult for the euro to continue to strengthen. And I also think you'll see more-- well, we haven't seen any substantial jawboning from the ECB. But I think they will be a little bit more active, in terms of potentially being a bit more dovish, and trying to talk down the gradual rise, if there is one, of the currency.
The market shouldn't be surprised about that, if that jawboning does start to--
No, but the market is also long, I think, to a certain extent, and you've seen significant repositioning. And you've also seen a substantial amount of reserve buying, which is really what's driven the currency over the last, I would say, couple of months.
If there there's one outstanding flow, it's really reserve managers, which have seen, obviously-- especially in emerging markets-- have seen quite a large increase in reserves, and they've been buying the euro. And reserve managers aren't seeing that because, obviously, we've-- they are not seeing continued reserve growth because we've seen a stop in the emerging market rally. So I think it's going to be tougher for the euro to rally going forward.
If there's a kind of a microcosm of that story about possible slowdown in growth in Europe, then perhaps we should look to Sweden and Norway. Those currencies, which had big sell-offs on the back of what were some worrying-- well, what looked like some worrying house price data. Obviously, Sweden particularly is very dependent on exports, and their whole economy seems to be built around a lot of housebuilding, and there's a lot of household consumption there. It was quite a violent fall and quite a big pickup, as well. We should expect further volatility in this currency?
I think that the violent fall took a lot of people by surprise, and there were some, as we market participants say, some stay-alongs in Sweden, which probably got flushed out. Because I think you correctly said, the economy is doing exceptionally well. It's a small, open economy, highly geared to the European business cycle, and particularly the German business cycle, so it should continue to do quite well.
Now, the issues around the housing market are issues which have been flagged for a long time, including by the Riksbank. They've tried to address them through macroprudential measures, I would argue, to a certain extent, quite successfully, as much as one can. I think we're in, similarly to what we've seen in many countries, as long as you have low rates, it's really difficult to see a housing bust. We're mostly likely going to see a plateau, maybe some weakness, which is healthy. And at the same time, you continue to have an economy which is exposed to the rest of the world and doing quite well. So the weakness is not really justified, other than, I would say, on technical. So we're quite bullish both on the Swedish krona and the Norwegian krone, actually, as well.
Except this is a test about the market's relationship with the central bank, just as it is with the ECB. I mean, we've been so used to the Riksbank almost having an ideological desire to keep rates low, that the market is saying, come on, now, this is-- it's surely time now. And the jawboning just goes on forever.
That's a very good point. And I think the fact that you had both the governor and the vice governor come out and actually talk about-- for the first time for as long as I can remember, meaning several years-- actually talk quite explicitly about supporting the currency rather than the opposite. I think that maybe this is a tipping point. And also inflation did disappoint, the [? last print ?] in Sweden, but let's not forget it's running the highest inflation of any--
It's very close to the top, isn't it?
Exactly. So I think we're closer to them seeing a reversal, even if that means just being on par with the ECB in terms of the repo rate. And that would be positive for the currency.
It's just almost like central banks are just too scared to see the other side of QE and tightening.
Yes. Well, I think that could be argued for many people, that many people are still living with that hysteria of 2007 and 2008, so--
Talking about central banks, and how much we can trust them, but Turkey, yet again, has an issue about central bank independence, President Erdogan talking about not wanting to see rates go high. But again, we had verbal intervention from his economic advisor on Thursday, which actually caused the lira to rally. It's always the same issue. It's, can we-- will we finally see the thing that has been resisted for so long?
I don't think so. I think we're still going to see the central bank continue to lose credibility. I think every verbal intervention will be less effective, and this is-- unfortunately, it's a country which is seeing a weakening of institutions across the board. So there's no reason to believe that we're going to see a turnaround there. And, actually, with a recent move in oil prices, the continued tension in the Middle East, and all the issues surrounding their domestic politics, I think the situation for Turkey continues to be questionable.
George, what has 2017 been like, as we draw to a close with it, in terms of pricing in political risk, an almost impossible thing to do anyway. And where does 2018 feel on that same issue?
2017, I think, was difficult for many, including ourselves, because we were quite concerned with political developments. Even if they weren't the base case, there were quite high probabilities around having some unfortunate outcomes. And, obviously, France stands out, but also even in the UK, there was a lot of concerns on how Brexit would develop. But markets have taken all these things quite well.
In their stride.
In their stride, exactly. And one of the surprises, really, how constructive the markets are on issues in the periphery. I mean Italy, for us, continues to be a point of concern. We are going to have elections next year, and according to the polls, the Five Star Movement is ahead. And as we know, and as we've seen in Germany, mainstream political parties continue to lose in terms of their popularity. Their polls just continue to be one way, which is probably why, in Germany, we're not going to see elections, because they're not going to be favourable for both SPD and the CDU.
So 2017 was difficult. And I think the markets were, to a certain extent, prepared. There was a lot of volatility buying, including from ourselves. I would argue, if you look at where volatility is priced, we'll continue to see a lot of systematic selling of volatility. While, I would argue that, again, we have, potentially, some important milestones, with the Italian elections being the most important, but also developments in Germany, to the extent that if Germany becomes more inward-looking, it becomes more difficult for them to manage the European, if you like, financial architecture.
The market may be a bit underpriced on 2018.
We feel so. And also, I think, the other thing is not only politics, but obviously it's the first time we're going to see a genuine decrease in central bank balance sheets.
Finally, does that change or give you a new perspective on where to put your money for 2018?
Well, we've been arguing to be long volatility in '17, and we'll continue to do so in '18. And I think, for the reasons that I just mentioned, it's not only politics, but it's also we're going to see continued tightening from central banks.
My thanks to George Papamarkakis of North Asset Management. Join us again next week to discuss all the big topics on the foreign exchange market. Until then, from Hard Currency, it's goodbye.