Tail risk, or tailwind?

At the turn of the year, money managers were fretting about the future of the euro area. They worried about an imperfect currency union with high levels of youth unemployment and increasing political polarisation.

It was hard not to be pessimistic. Italian bank balance sheets had high levels of NPLs. Meanwhile, a Marine Le Pen presidency, and with it Frexit, could not be ruled out. According to a Bank of America Merrill Lynch poll of global fund managers, EU disintegration was the biggest risk facing the global economy. However, in the first quarter, while some investors had been predicting its demise, the euro area economy was quietly expanding at a faster pace than either the UK or the US. And an avowedly pro-EU candidate won the French presidential election.

With the possibility of a new Franco-German partnership on the horizon, long-Europe has returned to fashion. In the first half of the year, the Euro Stoxx 600 rose by 13.5% in US dollars, outperforming other major developed markets. Meanwhile, the euro appreciated by 7% against the US dollar in the second quarter alone – its strongest three-month performance since 2010. The euro area went from being a tail risk to being a tailwind to the global economy. Whether this can be maintained remains to be seen.

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