If you’re wondering why the euro continues to rise, regardless of the surge in oil, it’s actually pretty simple, according to Citi’s Jeremy Hale.
What about risks the other way i.e. for an even higher EUR? These probably relate more to generalised USD weakness and further upside in commodity prices, particularly oil. Oil prices have been positively correlated with EUR/USD for some time (see Figure 73). One reason is the perceived asymmetric policy response by the ECB and Fed to higher oil prices, where the ECB typically responds more hawkishly. Another is that trade flows/ exports to the oil producers favour Europe over the US. But perhaps the main reason for this correlation relates to the same reserve diversification mentioned in the previous section. Higher oil revenues in USD are quickly banked in EUR, generating upwards pressure on EUR/USD.
One thing that could overrun this correlation and the current euro uptrend is the sovereign debt crisis spreading to Spain.
However, a key factor here is that markets are buying the EU line that a firebreak is now in place at Portugal’s border and that Spain will not need official support. We at remain sceptical about this given plenty of scope for further shoes to drop in terms of falling house prices, higher mortgage arrears, possible bank exposures to haircuts elsewhere in the periphery and so on. Because Spain is so much larger than the countries bailed out so far (nominal GDP is nearly double the number for the Po.Ir.Gr. 3 added together), this could present a totally new risk to the EUR at some point.
But for now, the euro is stuck into that correlation with oil.
NOW WATCH: Money & Markets videos
Business Insider Emails & Alerts
Site highlights each day to your inbox.