The euro: remaindered

26/6/2016

Worry more about the single currency than the pound

The pound lost 7 per cent against the dollar on Friday; the euro, less than 3 per cent. But the currency that is leaving may ultimately do better than the one that is to be left behind.

When Article 50 of the Lisbon Treaty is triggered, a two-year negotiating period begins. The “leave” camp is suddenly very wary of starting the clock, though. So the period of uncertainly is open-ended. During it, trade in rumour and hypotheticals will be lively. Other nations will be publicly rethinking EU membership while the discussions proceed. The euro volatility that inevitably results will be multiplied if there is economic weakness at the same time.

The knock-on effects of a weak euro will be significant. The biggest impact is likely to be on markets that perform poorly during periods of dollar strength. Dollar-priced commodities such as oil and copper are the first place to look, as a comparison of a trade-weighted dollar index to oil and copper prices over the past decade shows. On Friday, oil lost 5 per cent.

A similar negative correlation for the dollar exists with the MSCI Emerging Markets equities index. Latin American markets have the greatest commodity sensitivity, given producer constituents such as Brazil (iron ore), Mexico (oil) and Chile (copper). Better to own Asian emerging markets, especially India, in times of dollar strength. Asia has lagged behind this year’s commodity-driven rally in EM.
Wherever they are domiciled, oil and mining stocks have rebounded strongly since their February lows. They will suffer in the short term. Tullow Oil, the UK-listed oil explorer, lost 11 per cent on Friday. More indebted miners and steel companies, such as Glencore (down 8 per cent) and Amsterdam-listed ArcelorMittal (11 per cent) are particularly vulnerable.
The pound should reflect the risk of the UK going it alone. But it is the path of the euro, a more traded currency representing a larger share of world output, that most needs watching.

Πηγή