EUR: Trade-weighted strength masks USD weakness – Commerzbank

Commerzbank’s Volkmar Baur examines whether the Euro is truly weak or strong, noting that EUR/USD undervaluation on purchasing power parity contrasts with a still-elevated trade-weighted Euro. Undervalued Asian currencies, particularly the Renminbi and Taiwan Dollar, mechanically boost the Euro’s trade-weighted index, leaving it near the upper end of its 25-year range despite recent softening.

Trade-weighted euro distorted by Asia

"Admittedly, after this week, no one at the ECB will be asking whether the euro is too strong, as was the case last week."

"How can it be that the euro is perceived as too strong when, measured in terms of purchasing power parity, it still seems to be undervalued against the US dollar?"

"For me, the solution lies in the fact that the euro's exchange rate against the US dollar is by far the most important for the euro."

"But it is only one exchange rate among many. And when a strong euro is measured against an even stronger US dollar, it still appears weak."

"If we look instead at the trade-weighted euro as calculated by the ECB against 40 other currencies, we see that the euro has indeed weakened somewhat in recent weeks. However, its all-time high on 28 January is not that far behind."

"Together, the RMB and the TWD account for around 17% of the trade-weighted euro, as calculated by the ECB. This means that these two currencies alone make the euro around 5% stronger than it would be if these currencies were not so severely undervalued. In this case, the trade-weighted euro would still be at the upper end of its trading range over the last 25 years. But it would no longer be significantly stronger."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)