Euro Bears Vanish as Stress End Makes Goldman a Bull (Update2)

By Matthew Brown
July 26 (Bloomberg) -- The combination of growing confidence in Europe’s economy and mounting evidence of a slowdown in the U.S. is driving euro bears into hiding.
After tracking the euro’s slide from about $1.45 at the beginning of 2010, the median forecast of currency strategists has stayed within two cents of $1.20 since the start of June, according to data compiled by Bloomberg. Goldman Sachs Group Inc. and Wells Fargo & Co. raised their estimates in the past two weeks, joining HSBC Holdings Plc and Deutsche Bank AG in predicting a stronger euro.
While the euro weakened 15 percent in the first half as the region’s debt crisis threatened to tear the currency union apart, investors have shifted their focus to the U.S. as the dollar depreciated 8 percent from a four-year high in June. U.S.
economic data fell short of economists’ estimates this month by the most since March 2009, while euro-region reports exceeded forecasts since April, according to Citigroup Inc. indexes.
"People got a bit too excited about the idea the euro-area was going to break up and forgot that the U.S. has a whole load of problems of its own," said David Bloom, global head of currency strategy at HSBC in London, who has predicted since the start of June that the euro would end the year at $1.35.
Confidence in the euro returned after the most-indebted countries in the region announced budget cuts and the European Union crafted a 750 billion-euro ($970 billion) financial backstop in May to forestall defaults. Spain, Portugal, Ireland and Greece successfully auctioned more than 17 billion euros of bonds and bills since July 13.

Economic Outperformance

Speculation the recovery would accelerate increased when Germany’s Ifo institute said July 23 that its business climate index unexpectedly jumped to the highest level since July 2007.
A composite index of European services and manufacturing industries climbed to 56.7 in July from 56 the month before, London-based Markit Economics said a day earlier.
Investors showed little surprise on July 23, when the Committee of European Banking Supervisors said seven of 91 EU banks subject to stress tests failed with a combined capital shortfall of 3.5 billion euros.
The euro rose 0.2 percent to $1.2933 as of 8:48 a.m. in London, after appreciating in three of the past four weeks. The 16-nation currency appreciated 8.9 percent since June 7, when it slid to $1.1877, the weakest level since March 2006. It also advanced 2.5 percent since falling to a more than seven-year low on June 29, according to Bloomberg Correlation-Weighted Currency Indexes.

Outlook Reversed

Analysts are raising their forecasts as Citigroup’s euro- region economic surprise index reached a three-year high of 131 on May 27. The equivalent U.S. gauge fell to a 16-month low of minus 43.6 on July 1. The measures examine historical standard deviations of data surprises by comparing releases with Bloomberg median estimates.
Goldman Sachs analysts led by Thomas Stolper in London reversed their outlook for the euro twice in two months, and said in the most recent forecast that the dollar will weaken against the euro by January as U.S. growth slows. The New York- based bank says the shared currency will reach $1.22 in three months, $1.35 in six months and $1.38 in a year. As recently as June, Goldman Sachs forecast the dollar would surge to a seven- year high.

Weaker Growth

"Weaker U.S. growth, reasonably solid euro-zone macro data and less political-fiscal disruptions than feared have been a feature of the past few weeks," Goldman Sachs analysts wrote in the report dated July 14.
Wells Fargo, based in San Francisco, raised its six-month euro forecast to $1.24 from $1.20 on July 14, said Vassili Serebriakov, a currency strategist in New York.
"The main positives for the euro have been stronger-than- expected euro economic numbers and a recovery in risk appetite," he said. Serebriakov said the euro will weaken longer term, falling to $1.18 in 12 months.
While U.S. growth has slowed more than forecast, the economy will still outpace Europe over the coming year as budget cuts start to brake the recovery, said Ian Stannard, a senior foreign-exchange strategist in London at BNP Paribas SA. The Paris-based lender scaled back its forecast for a decline in the euro on July 23, saying it will fall to $1.12 in the first quarter, from a previous prediction of parity.

‘Still in Place’

"The reasons why a weaker euro are both likely and needed are still in place," said Stannard. "The market still hasn’t really adjusted to the prospect of lower euro-zone growth once the fiscal tightening that has been announced is implemented and begins to bite."
The U.S. economy will expand 3.1 percent this year, according to the median of 55 analyst forecasts compiled by Bloomberg. The euro-region will grow 1.1 percent, a separate median estimate shows.
German Chancellor Angela Merkel’s Cabinet approved four years of budget reductions and revenue programs worth 81.6 billion euros on July 7. Greece aims to cut its budget deficit to 8.1 percent of gross domestic product this year, from 13.6 percent in 2009, and meet the EU’s 3 percent limit by 2014.
Portugal plans to reach the EU target by 2012, reducing it from
9.4 percent last year.
The euro-region deficit will narrow to 6.1 percent of GDP in 2011 from 6.6 percent this year, according to European Commission forecasts on May 5. The U.S. gap will hit 10 percent in 2010 and 9.9 percent next year, the figures show.
While European governments are pruning, U.S. President Barack Obama signed into law a $34 billion extension of unemployment benefits on July 22.

Treasury Yields

"The market seems to be favoring regions where policymakers are taking an active role on deficit reduction and that’s not the U.S.," said Thanos Papasavvas, who helps manage more than $5 billion in currencies at Investec Asset Management Ltd. in London. "For Europe it may be painful in the short- term, but they are dealing with it. The U.S., which has a much bigger problem, isn’t even beginning to deal with it."
At the same time, the bond market is telling the U.S.
government to focus on growth, not the deficit. Yields on two- year Treasury notes fell to a record low 0.5516 percent on July
23 and are 16 basis points, or 0.16 percentage point, less than similar-maturity German debt.
Housing starts in the U.S. fell more than forecast last month, the Commerce Department said July 20. Initial jobless claims rose to 464,000 in the week ended July 17, exceeding the highest estimate of economists surveyed by Bloomberg, Labor Department figures on July 22 in Washington showed.

Bearish on Dollar

Futures traders turned bearish on the dollar for the first time in almost three months on July 13, according to data from the Commodity Futures Trading Commission in Washington. So- called short positions, or bets prices will fall, by hedge funds and other large speculators outnumbered long positions by 99,175 on July 20, CFTC figures show.
The changing fortunes for the euro and the dollar caught foreign-exchange funds by surprise, according to the Parker BlackTree Currency Index, which tracks 22 currency funds that manage about $15 billion. The index lost 1.7 percent between May 14, when valuations reached the highest level since November, and July 16.
"Foreign exchange is the world’s biggest fruit and vegetable store, with millions of people playing it 24 hours a day," Goldman Sachs Chief Global Economist Jim O’Neill said on July 21 in a radio interview with Tom Keene on Bloomberg Surveillance. "Anybody who thinks they can get foreign exchange right all the time should be in a lunatic asylum."