The euro, the world's second-most commonly traded currency, has experienced significant periods of volatility since its introduction to international markets in 1999. Its strength against the dollar hit a high in July 2008, when one euro was worth $1.60. Since that time, the euro has dropped significantly in value. In November 2015, the euro traded between $1.06 and $1.10, with the value of the currency losing strength at the end of the month.
The most direct method of investing in a foreign currency is through the foreign exchange market (forex). The forex is different from the stock market; due to the interrelated nature of the currency markets, investors hedge positions in pairs of currencies to mitigate risk.
Countries worldwide also make investments such as stock shares and bonds available to foreign investors. This method of investing in currencies is less direct and also carries the risks and potential rewards associated with the specific investment vehicle. Domestic banks, at times, offer certificates of deposit (CDs) that are based in foreign currencies.
Risk
To open a long-term position into any financial instrument, you must complete adequate due diligence research to ascertain the most advantageous time to enact the transaction. By breaking investments into smaller portions and adding on to a position or opening new ones based on developments in the market, you benefit from using new insight to manage the potential performance of an instrument or a currency. When you open a long-term position in a currency, you lose this valuable ability in exchange for the pursuit of more attractive gains.
The volatility of the euro reflects the economic status of the member nations of the European Union. As of late, several nations in Europe, such as Greece and Spain, have experienced severe financial crises. By taking a long-term position in the euro, you must consider future debt and political instability issues of member nations that may negatively impact the value of the euro. Decide how much of a negative decline in the value of the euro you are willing to tolerate before exiting the position – and likewise, if the potential strengthening of currency value following a crisis warrants keeping the position.
The horizon of exit of the investment should be flexible by several years to manage future upsets such as financial crises in member nations and recessions. If a highly favorable exit is available a few years prior to the date of the planned closing of a long-term position, then your strategy should allow the position to be closed at that time. A comfort zone of several years following an unforeseen weakening of the euro at the planned time of exit would allow you to hedge against additional losses by being forced to exit when the euro is weak.
Not all European nations have entered the European Union. Lithuania only entered in January 2015. A significant risk associated with a long-term position in the euro is that you will have to project the future strength of markets currently in the eurozone in addition to the strength of nations that have yet to enter the eurozone, and use the euro as their currency, including Bulgaria, Croatia, the Czech Republic, Denmark, Hungary, Poland, Romania, Sweden and the United Kingdom.
Overall, the eurozone has shown signs of entering into yet another recessionary period. This runs counter to repeated statements made by the president of the European Central Bank, Mario Draghi, since he took the position in 2011. The April 2015 edition of the World Economic Outlook of the International Monetary Fund (IMF) reports that several nations in the European Union are still suffering from high debt, weak banks, low growth and low growth of output, and current projections do not point toward significant recovery. In 2013, several figures – including the IMF – made statements suggesting that a recovery in European financial markets was underway, though this is not what eventually developed. If you are placing sums of money into the euro, be prepared for market changes that are counter to the forecasts of popular economic authority figures, and make decisions without partiality to the opinions of political leaders.
Likely impacting these conditions is the euro area's low interest rate of 0.05%. The United States has experienced a recovery more significant than the euro area's in 2013 and 2014, with output at 2.4% in the U.S. and 0.9% in the euro area. The IMF's projections for 2016 set growth at 3.1% in the U.S. and 1.5% in the euro area.
Rewards
As it stands, the euro is not in good shape. Its exchange rate reflects the weakened state of the eurozone's member nations. This does not mean that the eurozone will be in such a state over the next 20 to 30 years. The most advantageous aspect of investing for the long term is that you may benefit from potentially realized large swings occurring over time, and you may exit the position when you perceive that the euro is at its strongest against the dollar. The potential for significant rewards realized by holding a long-term position in the euro is based on the likelihood of recovery over decades rather than over years.
The European Union has poured trillions into long-term loans to banks, refinancing operations, a quantitative easing purchase plan of government bonds and covered-bond programs. A vast majority of the funds spent have been on assets, including assets in emerging economies. All of this spending is likely to have a positive effect on the eurozone. For investors, it is a matter of when and how these measures will emerge in European markets as a means of helping economies and the euro.
Over long periods of time, there tend to be corrections to periods of downturn and loss. The potential rewards of investing in the euro are better-suited for a long-term position with a flexible exit to accommodate future developments in member nations and future plans announced by policymakers to support growth in production and desired rates of inflation.
