The Euro Rallies, but Strong Currency Will Slow Continent's Rebound

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Lackluster revenue growth seems to the biggest pattern coming out of second quarter earnings so far. Tech giants IBM (IBM) and Texas Instruments (TXN), for example, both reported weak top line results despite beating earnings forecasts.

But stocks may find an unexpected pocket of strength. Investor panic about Europe's debt load is fading fast. And fairly rigorous bank stress tests on the Continent, expected at the end of the week, could further ease nerves.

The sharp rebound in a currency that many Wall Street investors had forecast was headed for an outright breakup just months ago comes an opportune time for the stock market. Easing fears could help offset what seems to be a disappointing financial reporting period for American companies.

Something Else to Worry About

The spiking euro leads to a new set of worries, though. The sagging currency has been the saving grace for Europe's struggling southern region. Exports got a competitive boost thanks to a weak currency, and that helped moderate what is likely to be a painful deflationary period ahead.

For already strong industrial economies in the north like Germany and Sweden, the weak euro has merely been icing on the cake, and it led to sharp accelerations in exports. But a continued rise in the euro could hinder a broader economic recovery.

"If the euro continues to appreciate, it would be disaster for the eurozone," Ken Wattret, chief euro-area economist at BNP Paribas told Bloomberg News.

A deteriorating US economy, meanwhile, could push the euro to rally further. Much of the strength in the dollar relative to the euro since the start of the year was based on the divergent economic outlooks for the two regions.

Weakness Across the Atlantic

As late as April – when the US seemed on track for a sharp recovery even as Europe limped along – investors were betting that US policymakers would tighten monetary policy at a faster rate than had been expected compared to their European counterparts.

But as the Fed meets this week amid growing signs that the US economy is headed for a slowdown, tightening seems to be out the window. Anticipated differences in interest rates are also declining fast.

Investors should welcome the stabilization of the euro, when all the factors are taken into account. While it may slow the European recovery, it will also make American goods cheaper on the world market. Risk-taking will get a boost overall as fears of an implosion in Europe – overdone though they may have been – wane. And that should help cushion stocks.

Besides, there seems to be plenty to worry about at home, as is.
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