European investors risk a double hit from the recent currency moves, as a falling dollar and resurgent euro erode returns on unhedged US assets and weigh heavily on the earnings of European companies with substantial dollar exposure.
The euro’s sharp appreciation involves a compounding risk: losses on Wall Street are magnified in euro terms, while the profits of many euro-listed multinationals are being squeezed by currency translation effects as they draw a substantial share of their revenues from the United States.
Since late February, the single currency has climbed nearly 10 per cent against a basket of major trading partners, putting April on track to be its strongest month since 2022. This shift in the currency environment is forcing investors to reassess the vulnerability of their equity portfolios to exchange rate volatility on both sides of the Atlantic.
The Euro Currency Index (XDE), which tracks the euro against the US dollar, British pound, Japanese yen and Swiss franc with equal weighting, has surged in recent weeks. The stronger euro is weighing on European corporate profits, especially for firms in the Stoxx 600, which derives nearly two-thirds of its revenues from abroad — almost half from the US, according to Goldman Sachs.
Euro Currency Index
Every 5 percent gain in the euro and other local currencies slices 1.5 to 2 percentage points off earnings growth in the MSCI Europe index, according to Morgan Stanley. BNP Paribas reckons a 10 per cent jump in the euro alone typically knocks 2 to 3 per cent off corporate profits.
“The third quarter will be the eye of the storm,” said Florian Ielpo, head of macro research at Lombard Odier, in an interview with Bloomberg. Current earnings results are unlikely to reflect the full impact of the tariff regime.
Dollar weakness
Much of the trouble that European investors have faced this year comes from the poor performance of US stocks, and the dollar. The S&P 500 is down 6.5 percent year to date, but Europeans who didn’t hedge their dollar exposure are looking at a ytd return of -16 percent.
Morgan Stanley and Bank of America reported an increase in clients’ willingness to protect against dollar declines but according to State Street custodial data, overall currency hedging by foreign investors in US stocks stands at a mere 23 percent. That’s still well below the near 50 percent level seen in 2020, according to Bloomberg.
Pressure on the dollar will likely persist as long as US equities are not rebounding. In the near-term, a buyers’ strike towards the dollar points to “further tactical weakness unless US equities stabilize to drive inflows”, said Laura Cooper, head of macro credit at Nuveen.
“Even structurally, looking over the medium to long term, an expensive dollar, with the real effective exchange rate trading at a two-decade high, alongside a strategic reallocation of foreign assets away from the US portends further dollar declines,” she told Investment Officer.
Unhedged euro portfolios suffer steep losses
Soul searching
This new currency environment has prompted some serious “soul searching” among asset managers, says Mark Dowding, CIO at BlueBay Fixed Income. He has observed rapid rethinking of asset allocation among clients.
“With US policy actions prompting varying degrees of anger and resentment around the globe, we have already witnessed consumers look to boycott the US. In this context, this applies to capital allocations as well,” he said.
Meetings with Asian investors had revealed a structural overweight towards the dollar, which now appears under review, he said. “It is tempting to think that the dollar, a multi-year beneficiary of international flows, may have reached an important inflection point,” Dowding said.
Further euro gains
There may be some short-term respite in the USD following a period of weakness as Trump rows back on some of the aggressive tariffs announced on April second. In the near term however, currency strategists see scope for the euro’s advance to continue even though currency markets are notoriously hard to predict.
Deutsche Bank’s George Saravelos argues the era of US exceptionalism “has already started to erode.” He forecasts the euro reaching 1.30 dollars by the end of 2027. That level was last seen in 2014. At Danske Bank, currency analyst Kirstine Kundby-Nielsen believes Europe is becoming a more viable investment alternative and sees the euro hitting 1.22 dollars within the next 12 months.
Asked for tactical advice Dowding suggests investors should be cautious before extending short-dollar positions but notes that “opportunities could emerge if the euro pulls back towards 1.12.”
EUR/USD is currently trading at 1.14.
Last week’s data from the Commodity Futures Trading Commission supported “anecdotal evidence” that money funds and hedge funds are taking profits on dollar shorts, according to Chris Turner, head of FX strategy at ING. Longer-term institutional investors continue to reduce dollar holdings.
Reserve currency status questioned
The shifting flows are also reviving deeper - and systematically recurring - questions about the dollar’s long term future. The share of US-dollar denominated global reserves has already declined from 66 per cent a decade ago to about 58 per cent today.
Global reserves in USD are slowly shrinking
Part of the dollar’s erosion is political. When a sitting president talks about firing the Fed chair, even in passing, it undermines central bank independence. That’s an essential pillar of any reserve currency. Axel Botte, head of market strategy at Ostrum AM, argued that U.S. trade and economic policies are accelerating the shift away from the dollar.
The damage, he said, comes in three forms: threats to Fed independence, unsustainable fiscal deficits, and the administration’s proposal to build a bitcoin reserve. Those moves are seen by many as a deliberate move to debase the dollar.
“If that’s the goal,” said Botte, “the rest of the world won’t go along.”
For now, the dollar however remains unrivalled. “There is no viable USD alternative at this juncture given the depth and liquidity of US markets,” Cooper said.
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