The Euro looks to be 10-15% undervalued, according to BIS real exchange rate data. Changing capital flows prompted by (1) improving economic data and (2) less dovish statements by European policy-makers are pushing back towards this equilibrium. In short, the Euro could be a key beneficiary of US dollar weakness over coming months. What is different in this report is the evidence we bring of the broadness of Eurozone economic recovery and the fact that the long-slated end to ECB QE may already have started.
This report argues that World government bond markets are risky because of Chinese reflation and the progressive recovery of the Eurozone economies. Curiously, this threat is only partially explained by rising inflation pressures. The bigger risk comes from a prospective ‘re-normalisation’ of bond term premia. This is largely a capital flow story. Some US$3 trillion poured out of the Chinese and Eurozone economies into ‘safe’ (largely US) government bonds between 2012-15 – it now seems to be heading back. US 10-year governments could test 4% yields and the US dollar could fall 10% over the next 12 months.