As political risks to the euro wane, analysts now expect the currency to follow eurozone economic growth higher, leaving a long period of weakness behind it.
Continue Reading Below
The euro fell against the dollar Monday, but investors believe that Emmanuel Macron's victory in the French presidential election should alleviate some of the political concern that has dogged the currency. Investors say they can now refocus to Europe's economic recovery, a performance that is also likely to push the European Central Bank closer to tapering the massive stimulus program that has been another factor keeping pressure on the euro.
The single currency has been a symbol of Europe's economic malaise for several years; a rebound would underscore increasing economic optimism in the region, even as it may bring its own problems, not least by making local exporters less competitive.
Mr. Macron, a pro-European Union former banker, won 66.1% of a vote that pitted him against Marine Le Pen, the far right candidate who had promised to pull France out of the EU.
The euro rose by around 0.3% in the hours after voting closed, but was trading down 0.5% at $1.094 in European afternoon trade. The currency had already risen following Mr. Macron's victory in the first round of the vote.
"Populism hasn't gone away, but for now it's been pushed onto the back burner," said Jane Foley, senior foreign exchange strategist at Rabobank.
Continue Reading Below
"It's going to be more economics and less politics for the next six, eight, nine months," she said, predicting the euro will end the year at around $1.10.
The single currency fell to as low as $1.035 in late December, and many analysts were betting it would fall to parity with the dollar by the end of this year.
But in recent months, political concerns have eased and economic data gained, pushing the euro higher and forcing investment banks to boost their outlook for the currency. Last week, Bank of America, Merrill Lynch and Deutsche Bank both raised their forecasts for the euro, to $1.08 and $1.02 at the end of 2017, from $1.05 and 97 cents respectively.
Ahead of Sunday's election, investors were reducing their short positions against the single currency as they began to bet that Ms. Le Pen's chances of being French president were fading.
Fewer investors are now shorting the euro than at any time in the past three years, according to data from the U.S. Commodity Futures Trading Commission. In the week to May 2, there were only 1,653 more short than long contracts against the euro, sharply down from 127,434 in November.
The number of short contracts peaked at 127,434 in November and is now near its lowest levels since the middle of 2014, before the ECB's bond-buying program began.
The ECB is still buying EUR60 billion ($65.5 billion) in government and corporate bonds each month. Minutes from the ECB's governing council meetings show that officials' worries about political uncertainty were one reason they were keeping monetary policy unchanged.
Investors now expect the central bank to signal in June that it is closer to tapering its buying program, so-called quantitative easing.
The central bank's negative-interest-rate policy and asset buying has put pressure on the euro because it pushes down bond yields, making the region less attractive for foreign money looking for income, which would drive up the currency.
A faster reversal of the program would likely mean a stronger euro, analysts say.
"If you see strong growth, we could see a very sharp cliff for quantitative easing, meaning very little QE in 2019," said Alain Zeitouni, senior portfolio manager at Russell Investments. "That's not our base case, but it would create big volatility in fixed income and currency markets."
Few doubt, though, the brighter economic prospects. Core inflation reached its highest level in four years in January and business surveys suggest the stronger economic growth is continuing.
Still, a stronger euro isn't necessarily all good news for the ECB or the region's exporters. A weaker currency can help stoke much needed inflation in the eurozone and acts as a competitive advantage for local exporters.
For now, the eurozone's better prospects are boosting interest in local companies, helping spur better prospects for equities in the region, which will also buoy the euro as stocks attract foreign money.
International investors were more concerned than their French peers about this election in the early months of the year. Mr. Macron's victory could be a catalyst for their return, according to Philippe Lespinard, co-head of fixed income at asset management firm Schroders.
Foreign investors fled European equities in 2016. According to data provider EPFR Global, $7.66 billion has entered European equity funds in the year to date.
"The key reasons why you wouldn't be a buyer of [European] assets have gone away," added Pierre Bose, investment strategist at Credit Suisse.
To be sure, not all forecasters see the euro powering higher from here, or even holding its current gains.
Political and economic risks haven't completely gone away. Italy needs to call a national election before May 2018 in an election that could see anti-euro candidates gain ground in a country beset by economic problems. The EU will also be losing one of its biggest economies when Britain exits sometime around early 2019. While many analysts believe the U.K. will be hit hardest should it not get a favorable trading deal, Britain is a huge buyer of the eurozone's goods, from German cars to Italian wine.
Joe Prendergast, a strategist at Credit Suisse, also points out that interest rates in the eurozone remain way below those in the U.S.
U.S. two-year bond yields are now 2 percentage points higher than their German equivalents, near the highest levels on record. As recently as the end of 2011, German short-term yields were higher than their U.S. peers.
Write to Mike Bird at Mike.Bird@wsj.com
(END) Dow Jones Newswires
May 08, 2017 11:58 ET (15:58 GMT)