Market Musings: AUD/EUR: signs of life emerging

The jump up in the EUR over March, particularly in the first few weeks of the month, on the back of the optimism about the Eurozone’s growth prospects stemming from the ‘sea change’ in fiscal/defence spending, has been a key theme in FX markets (chart 1). The EUR’s resurgence has also been an important force that has dragged crosses like AUD/EUR and NZD/EUR to the lower end of their respective multi-year ranges.

At face value, the underlying shift coming through with regards to fiscal spending and infrastructure investment by governments is a longer-term economic support for Europe. This helps reinforce our long-standing thoughts that the macro fundamentals which drive AUD/EUR have entered a regime like the pre-GFC world when the cross-rate traded a couple cents either side of a ~0.60 average. This contrasts the post-GFC period many participants may have become accustomed to when AUD/EUR averaged ~0.68 (chart 2).

That said, markets are driven by outcomes relative to expectations. And we think the EUR’s climb (and drop in AUD/EUR) has run too far too fast. Our ‘fair value’ model suggests AUD/EUR should now be tracking closer to ~0.60 rather than near ~0.5850 (chart 3). Indeed, even after partially rebounding over the past week or so AUD/EUR is still more than 2 standard deviations from its rolling 1-year average. Historically, AUD/EUR hasn't been this ‘stretched’ for too long before snapping back more meaningfully (chart 4). This is where we feel the risks reside over the period ahead as the newfound bullish EUR sentiment (as illustrated by the swing in CFTC futures positioning) butts up against economic reality and/or lingering AUD bearishness fades (chart 5).

As mentioned, what is going on in Europe is a positive longer-term story for growth and in turn the EUR. However, we doubt the defence and infrastructure spending taps will be opened that quickly, even with the mooted rejigging to regional ‘debt brakes’ that have traditionally stifled government investment. The European Commission has indicated that an extra EUR800bn in defence spending could be delivered over four years (chart 6). At the same time, the new German Government is aiming to implement a EUR500bn infrastructure fund. These are large numbers but they are ones that are unlikely to start generating a growth tailwind until the back of this year, at the earliest. Even then given the bulk of defence spending is imported the multiplier effect across the broader Eurozone economy might not be that significant, while Germany’s infrastructure scheme is reportedly set to be spread over a 10-12 year period.

Additionally, the EU is still facing near-term tariff headwinds. The trade and production driven EU economy is deeply intertwined with the US. In 2024 the EU was the US’ biggest export market and accounted for the largest share of US goods imports (chart 7). The latest announcement by the US that 25% duties will be imposed on vehicle imports, and warning tariffs on pharmaceutical products are in the pipeline should re-focus the markets attention on the challenges facing the EU. On our figuring, autos equate to ~16% of the US’ imports from Germany, with the EU accounting for the bulk of the US’ imports of Chemicals/Pharma products (~52%) and ~20% of several other categories (chart 8).

The announcement of the US’ ‘reciprocal’ tariffs is just around the corner (due 2 April). President Trump has labelled it “Liberation Day”. We believe the EU could be in the direct firing line due to the sizeable and persistent trade deficit the US runs with the region, and because of the high VAT/GST rates in operation across Europe. This is something the Trump Administration has suggested creates a disadvantage for US exports. If punitive broad-based tariffs are imposed on the EU, based on what has happened before, we would expect the EU to fight back and announce countermeasures. In our opinion, if this is realised, the EUR may give back ground which in turn can help AUD/EUR edge up towards where our model suggests it should be. We think another relative AUD support is the fact Australia has minimal direct trade with the US. As discussed before only ~4% of Australia’s exports are sent to the US, and Australia is one of the few nations the US runs a trade surplus with (i.e. the US exports more to Australia than it imports from Australia).

Peter Dragicevich Currency Strategist - APAC peter.dragicevich@corpay.com