The European Union had barely reached a last-gasp agreement with Greece to hold negotiations on a new rescue plan, keeping it in the continent's common currency, when the euro abruptly plummeted in value.
Within just a few days of the marathon talks in Brussels in mid-July, the euro slipped from $1.12 to $1.08. It remains around that level today, having risen only slightly to trade above $1.09 on Friday. What is particularly odd is that the euro has continued to decline even as stocks in Europe have recovered (see graphic below).
The decline in value has raised some tough questions for the 16-year-old currency bloc, which includes 19 countries ranging from Ireland to Latvia. Is the euro degenerating into a soft currency? Is Europe turning into a transfer union, where richer members constantly have to bail out their poorer peers, combined sluggish economic growth in all member states and a common currency that is constantly weak?
But for others, it's a sign of a rather bizarre trend that could actually keep the currency from collapsing further: "Bad news supports the euro, while growing confidence has an adverse effect on it," said David Kohl, an expert at the Swiss private bank Julius Bär.
The reason is that, due to record the low interest rates in Europe, the euro is becoming a financing currency for projects in other countries. It means that in times of crisis, investors are likely to buy – not sell – additional euros in order to pay off their growing debts from these foreign investments.
A comprehensive study by German cooperative bank DZ Bank confirms that the euro is becoming increasingly important as a financing currency, along with the Japanese yen. As evidence of this, the bank points out that a growing proportion of new issues by international debtors being denominated in euros. Their share in all new issues rose by 9 percentage points in 2014, reaching 29 percent at the end of the year.
The euro, in short, is growing up. It's a dynamic that might explain why the euro hasn't plummeted further, despite the many predictions that earlier this year that the euro was doomed to weaken.
Bad news supports the euro, while growing confidence has an adverse effect on it. David Kohl, Julius Bär, Swiss private bank
Even before the dispute with Greece escalated and the country's possible departure from the euro zone was considered, many experts were predicting that the euro was set to fall further in the coming year.
Jan Hatzius, chief economist at U.S. investment bank Goldman Sachs, for example, was firmly convinced back in April that the euro would achieve parity with the dollar in 2015.
Ulrich Stephan, head of investment strategy at Germany's Deutsche Bank, also expects the euro to reach parity with the dollar by the end of the year. Explaining why he believes this, Mr. Stephan said: "I expect the first two interest rate changes (by the U.S. Federal Reserve) to take place in September and December."
However, those who take the opposite view and expect the common currency to recover or at least stabilize also have strong reasons.
"There aren't really any new arguments for a further decline, so it is likely that the euro/dollar rate will recover again over the medium term," says Christian Apelt, a foreign exchange expert at German bank Helaba.
Mr. Apelt said that ultimately the foreign exchange market has been pricing in the Fed's interest rate change for the last year, and there has been little change in the yield advantage of two-year and ten-year U.S. government bonds compared to German government bonds – an indicator of a growing gap in interest rates. He believes that the common currency could rise as high as $1.20.
Part of the reason is that, despite the debt crisis, the euro seems to be undervalued compared to its economic strength. Just look at the infamous Big Mac Index, a gauge calculated by the Economist magazine every six months that measures the price of McDonald's famous burgers around the world.
In relation to the dollar, the world's dominant currency, the index suggests the euro is undervalued by almost 16 percent, a level not seen since the common currency was introduced in 2002. According to this index, the euro should actually be at $1.29.
The Big Mac Index measures where fair exchange rates should be, based purely on economic fundamentals – in other words without intervention by central banks, for example. The analysis is based on a comparison of the purchasing power of different currencies.
But it is the euro's increasing use as a currency to finance global projects that is also having a major effect, and one that seems counter-intuitive at first glance.
The European Central Bank noted this trend a few months ago: Investors are borrowing money cheaply in euros in order to finance riskier investments in other currencies. This is a similar strategy to so-called carry trades, in which investors borrow currency in countries with low interest rates in order to purchase currency in countries with higher ones.
When a crisis comes along, investors need to sell their positions again. In order to pay their debts in the euro zone, they need to buy euros, and this growing demand then leads to a rise in the value of the euro.
This explains a link that investors have been observing for the last year: Share prices have been moving in the opposite direction to the euro: if the DAX index of Germany's 30 leading shares rises, the euro falls, and vice versa.
Julius Bär, the Swiss bank, says that the performance of the euro is not a very suitable yardstick for assessing Europe's rescue policy, pointing out that the currency also slipped when the bailout plan for Portugal was agreed some years ago. By contrast it rose after commitments were made to Cyprus last year.
The euro's growing attractiveness as a financing currency is likely to continue for some time, as interest rates in the euro zone are set to remain low in the medium term. The result is that the euro will probably continue rise in times of crisis.
This is not necessarily a good thing, however, said Yahya Yousofzai, a foreign exchange analyst at DZ Bank. He noted that a strong euro will ultimately weaken the export industry, an important economic pillar of the euro zone.
Jürgen Röder reports on the financial markets from Handelsblatt's Düsseldorf bureau. To contact: [email protected]