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Archive for the 'Euro' Category

Forex Volatility Continues Rising

Jun. 17th 2011

This week witnessed another flareup in the eurozone sovereign debt crisis. As a result, volatility in the EUR/USD pair surged, by some measures to a record high. Even though the Euro rallied yesterday and today, this suggests that investors remain nervous, and that going forward, the euro could embark on a steep decline.

There are a couple of forex volatility indexes. The JP Morgan G7 Volatility Index is based on the implied volatility in 3-month currency options and is one of the broadest measures of forex volatility. As you can see from the chart above, the index is closing in on year-to-date high (excluding the spike in March caused by the Japanese tsunami), and is generally entrenched in an upward trend. Barring day-to-day spikes, however, it will take months to confirm the direction of this trend.

For specific volatility measurements, there is no better source of data than (whose founder, Arnaud Jeulin, I interviewed only last month). Here, you can find data on more than 30 currency pairs, charted across multiple time periods. You can see for the EUR/USD pair in particular that volatility is now at the highest point in 2011 and is closing in on a two-year high.

Meanwhile, the so-called risk-reversal rate for Euro currency options touched 3.1, which is greater than the peak of the credit crisis. This indicator represents a proxy for investor concerns that the Euro will collapse suddenly, and its high level suggests that this is indeed a growing concern. In addition, implied volatility in options contracts has jumped dramatically over the last week, which confirms that investors expect the euro to move dramatically over the next month.

What does all of this mean? In a nutshell, it shows that panic is rising in the forex markets. Last month, I used this notion as a basis for arguing that the dollar safe-haven trade will make a come-back. This would still seem to be the case, and should also benefit the Swiss Franc, which is nearing an all-time high against the euro. Naturally, it also implies that forex investors remain extremely concerned about a continued decline in the euro, and are rushing to hedge their exposure and/or close out long positions altogether. suggests that this could make the EUR/USD an interesting pair to trade, since large swings in either direction will necessarily create opportunities for traders. While I have no opinion on such indiscriminate trading [I prefer to make directional bets based on fundamentals], I must nonetheless acknowledge the logic of such a strategy.
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Posted by Adam Kritzer | in Euro, Investing & Trading | 2 Comments »

Euro Nears Breaking Point

Jun. 16th 2011

It’s deja vu all over again in the forex markets as another twist in the sovereign debt crisis has sent the euro tumbling by the greatest margin in nearly a year. It was only last month that I posted “The Euro (Still) has a Greek Problem,” and yet, forex markets are once again reacting to the possibility of a Greek default as thought it were a new development. At the very least, investors finally seem to be acknowledging the inevitable.

There have been several factors at work in this latest episode. On Monday, S&P downgraded its credit rating for Greece to CCC, following on a similar move by Moody’s. That means that Greece’s sovereign credit rating is now the lowest in the world, behind such eminent economies as Grenada and Ecuador. While the move was hardly noteworthy in itself, it represents one more straw on the camel’s back.

Greece’s government is increasingly unstable, and Prime Minister George Papandreou has become so desperate that he has suggested forming an alliance with Greece’s most powerful opposition party. Meanwhile, violent riots outside Greek Parliament have reportedly become a daily occurrence, as the Greek populace has proven unwilling to accept wage cuts and tax increases.

As if that weren’t enough, there is tremendous uncertainty surrounding the next stage of the Greek bailout. No one can agree on what amount to give and what should be stipulated in return. Some parties think that private investors should be involved in the bailout by taking a “haircut” on the bonds that they own. Some members of the eurozone are balking about contributing any funds at all, wary of justifying it to their own citizens and that it is merely forestalling the inevitable.

I think the NYTimes offered the best summary: “Funding fatigue is growing in the north European creditor countries, especially Germany, the Netherlands, Finland and Austria, just as austerity fatigue is mounting in Greece.” When you consider that Greek interest rates and credit default swap spreads have surged to record highs, it seems that default is really inevitable. If the IMF and European Union are so determined, they can push off default until 2013. Still, default now or default then is still default.

At this point, then, the only real question is what happens when Greece defaults. Will it be forced to leave the Eurozone? Will that push the rest of the Eurozone fringe closer towards default? Will the Euro collapse and cease to exist as a currency? What will happen then?

Unfortunately, I think the answer to all of these questions is yes. At the very least, Greece will be forced out of the eurozone. Bondholders will push interest rates in Ireland, Spain, and Portugal up to double-digit levels, trapping them in the same cycle in which Greece is currently ensnared. Given the exposure of French and German banks to the sovereign debt of financially troubled eurozone members, they will also require state bailouts, and so on.

In a recent op-ed published in The Financial Times, celebrity economies Nouriel Roubini argued that the only way to avoid a complete eurozone meltdown is if the euro depreciates rapidly “to restore competitiveness to the periphery” or if the European Union is able to rapidly achieve complete fiscal and economic union. Roubini argues that the former is difficult because of the ECB’s hawkishness, while the latter is precluded by political hurdles that remain too formidable to overcome.

As Greece inches ever closer to default, the markets will increasingly become gripped by utter uncertainty over the questions that I posed above. Central Banks will stop accumulating euro-denominated assets, and investment funds will similarly shun Europe. (In fact, there is already evidence that this is happening). While European interest rates are attractive relative to the rest of the G4, they are hardly enough to compensate investors for this uncertainty. And when the markets come to terms with this, the euro might finally reach its breaking point.

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Posted by Adam Kritzer | in Euro | 3 Comments »

S&P 500 Decouples from Euro?

Jun. 14th 2011

While I have written quite about forex correlations in recent posts, the focus has primarily been on correlations that exist between currencies. In this post, I would like to address a correlation that exists between currencies and other forex markets- specifically the relationship between the Euro and US stocks.

If you look at the chart above, you can see that an unmistakable correlation exists between the S&P500 and the EUR/USD that stretches back at least six months. Generally speaking, when the EURUSD has risen, so has the S&P 500, and vice versa. In fact, this correlation is so airtight that one analyst recently discovered that the two financial vehicles often reach intra-day highs and lows within minutes of one another!

Why is this the case? In a nutshell, it is because the Euro – especially relative to the dollar – is a proxy for risk appetite. The same is necessarily true for US stocks. When investors are confident in the strength of the global economic recovery and the possibility of crisis is distant, the euro will rise. This has nothing to do with fundamentals in Europe, which are probably at least as bad as they are in the US. Of course, it may be connected with dollar weakness, since it is arguably the case that quantitative easing has both depressed the dollar and buoyed US stocks.

As I intimated in the title of this post, however, the S&P recently decoupled from the euro. Since the beginning of June, US equities have declined sharply, to the extent that they have given back most of their gains in the year-to-date. The EUR/USD, meanwhile, continued rising all the way until last week. While this has happened on a couple previous occasions, this was perhaps the sharpest break between the two.

I’m personally at a loss to explain why this happened. It has been conjectured that the driving force behind the correlation is algorithmic trading, and that hence, it must also represent the source of the break. In other words, high-frequency traders – which account for an ever-increasing proportion of forex volume – tweaked their trading algorithms so as not to buy the S&P 500 when the EURUSD rises, and vice versa.

It’s probably also the case that S&P 500 was falling for endogenous reasons- specifically a decline in GDP growth and earnings expectations which need not necessarily reflect itself in a stronger euro. In fact, in a normal functioning market, you would expect an inverse correlation; strong US economic fundamentals should translate into both a strong dollar and rising stocks. Could it be that worsening fundamentals are manifesting themselves in the form of a weak dollar and weak stocks?

Alas, the correlation has re-established itself over the last week, which means this is largely a moot issue. At the very least, it’s still worth being aware of, both insofar as it remains intact and in the event that it breaks down again.

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Posted by Adam Kritzer | in Euro | 2 Comments »

The Euro (Still) has a Greek Problem

May. 18th 2011

Since the beginning of May, the euro has fallen by a whopping 7% against the dollar on the basis of renewed fiscal uncertainty in the peripheral eurozone. The optimists would have you believe that the markets will soon forget about the so-called sovereign debt crisis and just as quickly return their focus to monetary policy and other euro drivers. Personally, I think investors to follow such a course, as forex markets must eventually reckon with the seriousness of the eurozone’s fiscal troubles.

First, I want to at least acknowledge the primary sources of euro support. Namely, the European Central Bank (ECB) recently became the first “G4” central bank to raise its benchmark interest rate; at 1.25%, it is now the highest among major currencies, save only the Australian dollar. Moreover, there is reason to believe that the ECB will hike further over the coming six – twelve months. First of all, eurozone price inflation continues to rise, and the ECB is notoriously hawkish when it comes to ensuring price stability. Second, Q1 GDP growth for the eurozone was a solid .8%, thanks to especially strong performances from France and Germany. While the ECB will likely follow the lead of the Bank of England and wait until Q2 data is released before making a decision, the strong Q1 performance is nonetheless an indication that the eurozone can withstand further rate hikes. Finally, Mario Draghi, who has been confirmed to replace Jean-Claude Trichet in June as head of the ECB, will need to effect an immediate rate hike if he is to establish credibility with the markets.

As I wrote in my last euro update (“Time to Short the Euro“), however, such a modest ECB interest rate – regardless of how it compares to other G4 rates – should hardly be enough to compensate yield-seekers for the risks associated with holding the euro for an extended period of time. Of course, the primary risk I am talking about is the possibility first of a full-fledged sovereign debt crisis, and secondarily of a eurozone banking crisis.

At this point, it is painfully obvious to everyone except for EU officials that the status quo cannot continue. Bailout funds cannot be expanded and rolled over indefinitely, especially since 3 countries (Greece, Ireland, and Portugal) are now involved. Greece, which is certainly the most pressing case, faces skyrocketing interest rates and declining interest from creditors, even as its budget deficit and national debt rise and its economy shrinks. Under these conditions, there is no way that it can re-enter private bond markets in 2012 (as was originally expected), if at all.

Thus, the only question is, what will happen instead? If Greece were to leave the eurozone, it could inflate away its debt, devalue its currency, and decrease interest rates. Regardless of its merit, this possibility has been vehemently dismissed because of concerns that it would lead to the implosion of the euro, and it seems very unlikely. What if Greece were to restructure its debt, by demanding concessions from bondholders? Based on the bond covenants, it apparently has wide latitude to do so, and might not even face legal repercussions. This possibility is also opposed by the ECB and EU officials because it would force banks to take massive [see chart below] write-downs on their debt holdings.

Greece could similarly elect to “re-profile”- basically lengthening the bond maturities (no “haircut” on interest and principal), ostensibly to give it more time to retool economically and fiscally. While this is a popular option, it probably would only succeed in forestalling the inevitable. Finally, the EU (with help from the IMF) could continue to loan money to Greece, in exchange for more additional austerity measures and collateralized by sales of state assets. Alas, this would be met with stiff political resistance from Greece. Not to mention that the recent indictment of Dominique Strauss-Khan – head of the IMF- on rape charges has jeopardized what has been the highest-profile advocate for continued support of Greece.

It seems inevitable that Greece will default on all or part of its debt. That’s not to say that this would cause its economy to collapse, nor that it would precipitate the end of the euro. In fact, recent history is full of cases of countries that successfully declared bankruptcy and emerged several years later unscathed. In this way, Greece could probably eliminate half of its debt, and significantly ease the burden that it poses.

Of course, this would not only set a dangerous precedent for Ireland, Portugal (and perhaps even Spain and Italy), but it would also reverberate throughout Europe’s banking sector, and would probably necessitate multiple bailouts. But what’s the alternative? Dragging out the crisis with secret meanings and feckless proposals will only add to the uncertainty. If Greece and the rest of the eurozone can come to grips with its collective fiscal problem, it will certainly cause chaos in the short-term and a further decline in the euro. By removing uncertainty, however, it will buttress the euro over the long-term and allow it to remain in existence.

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Posted by Adam Kritzer | in Euro | 1 Comment »

Time to Short the Euro

Apr. 20th 2011

Over the last three months, the Euro has appreciated 10% against the Dollar and by smaller margins against a handful of other currencies. Over the last twelve months, that figure is closer to 20%. That’s in spite of anemic Eurozone GDP growth, serious fiscal issues, the increasing likelihood of one or more sovereign debt defaults, and a current account deficit to boot. In short, I think it might be time to short the Euro.

There’s very little mystery as to why the Euro is appreciating. In two words: interest rates. Last week, the European Central Bank (ECB) became the first G4 Central Bank to hike its benchmark interest rate. Moreover, it’s expected to raise rates by an additional 100 basis points over the next twelve months. Given that the Bank of England, Bank of Japan, and US Federal Reserve Bank have yet to unwind their respective quantitative easing programs, it’s no wonder that futures markets have priced in a healthy interest rate advantage into the Euro well into 2012.

From where I’m sitting, the ECB rate hike was fundamentally illogical, and perhaps even counterproductive. Granted, the ECB was created to ensure price stability, and its mandate is less nuanced than its counterparts, which are charged also with facilitating employment and GDP growth. Even from this perspective, however, it looks like the ECB jumped the gun. Inflation in the EU is a moderate 2.7%, which is among the lowest in the world. Other Central Banks have taken note of rising inflation, but only the ECB feels compelled enough to preemptively address it. In addition, GDP growth is a paltry .3% across the EU, and is in fact negative in Greece, Ireland, and Portugal. As if the rate hike wasn’t bad enough, all three countries must contend with a hike in their already stratospheric borrowing costs, ironically making default more likely. Talk about not seeing the forest for the trees!

If the rumors are true, Portugal will soon become the third country to receive a bailout from the EU. (It should be noted that as recently as November, Portugal insisted that it was just fine and that a bailout wasn’t necessary). Its sovereign credit rating is now three notches above junk status. Today, Greece became the first Eurozone country to be awarded this dubious distinction, and Ireland is now only one downgrade away from suffering the same fate. Of course, Spain insists that it is just fine and denies the possibility of a bailout. At this point, though, does it have any credibility? Based on rising credit default swap rates (which serve as a gauge of the probability of default), I think that investors have become a little more cynical about taking governments at face value.

I have discussed the fiscal woes of the Eurozone in previous posts, and don’t want to dwell on them here. For now, I’d only like to add a footnote on the extent to which their problems are intertwined.  Banks in Germany and France (as well as the rest of the EU) have tremendous balance sheet exposure to PIGS’ sovereign debt, which means that any default would multiply across the Eurozone in the form of bank failures. (You can see from the chart below that the exposure of the US is small, relative to GDP).

Some analysts insist that all of this has already been priced into the Euro. Citigroup Said, “The market is treating many of these [sovereign credit rating] downgrades as rearguard actions which are already well discounted.” Personally, I don’t think that forex markets have made a sincere effort to grapple with the possibility of default, which appears increasingly inevitable. In fact, when S&P issued a warning on the US AAA rating, traders responded by handing the Euro its worst intraday decline in 2011.

Any way you cut it, I think the Euro is overvalued. Regardless of what the ECB is doing, market interest rates don’t really confer much benefit to those holding Euros. Even if the rate differential widens to 1-2% over the next year (which is certainly not guaranteed, as Jean-Claude Trichet himself has conceded!) this isn’t really enough to compensate for the possibility of default or other risk event. Regardless of whether you want to be long or short risk, there isn’t much to be gained at the moment from holding the Euro.

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Posted by Adam Kritzer | in Euro | 6 Comments »

Pound Vs. Euro: Tie Game for Now?

Mar. 24th 2011

While I’m fondest of analyzing all currencies relative to the Dollar (after all, it’s what I’m most familiar with and is involved in almost half of all forex trades), sometimes its interesting to look at cross rates.

Take the Pound/Euro, for example, arguably one of the most important crosses, and one of a handful that often moves independently of the Dollar. If you chart the performance of this pair over the last two years, however, you can see the distinct lack of volatility. It has fluctuated around an axis of 1.15 GBP/EUR, never straying more than 5% in either direction. In fact, it’s sitting right at this level as I compose this post.

Yesterday, I read some commentary by Boris Schlossberg (whom I interviewed in 2010), Director of Currency Research at GFT. In the title (“Euro and Pound Go Their Separate Ways”), he seemed to suggest that a big move was imminent. Aside from noting that both currencies stand at crossroads, he declined to offer more concrete guidance on the direction of the potential breakout.

At the moment, the markets are gripped by risk aversion, caused by the Mid East political turmoil and the Japanese natural disasters. Once these events run their course and the accompanying market tension subsides, investors will need something else to latch on to. Perhaps the Bank of England (BoE) and European Central Bank (ECB) can fulfill this function, since both are on the verge of hiking their respective benchmark interest rates . Absent any other developments, the timing and speed of such hikes will probably dictate not only how these currencies perform against each other, but also how they perform against the Dollar.

Despite the numerous indications that both have given to the contrary, I don’t think either Central Bank is in a hurry to raise interest rates. Economic growth remains poor, unemployment is high, and inflation is still moderate. Neither is yet at the stage where it can unwind the monetary easing that it put in place at the height of the financial crisis. Moreover, both are wary about the potential impact of rate hikes on their respective currencies (a concern that I am ironically fomenting with this post).

It looks like the BoE will be the first to act. Combined with high energy prices, the bank’s easy monetary policy is putting extraordinary pressure on prices, and it now appears that inflation could reach 5% in 2011. In addition, the BoE voted 6-3 at its last meeting in favor of tightening, which means that a hike probably isn’t too far off. On the other hand, the ECB is talking tough, but it still doesn’t have much of an impetus to act. Inflation is moderate, and besides, the region’s banks remain too dependent on ECB cash for it to serious contemplate being aggressive.

Either way, the interest rate differential probably won’t be great enough to encourage any short-term speculation between the two currencies. In addition, I think investors will continue to look to the Yen and the Dollar for guidance, and we won’t see any significant movement in either direction. [The chart below is based on benchmark lending rates and isn’t necessarily applicable for retail forex trading].

This would create two opportunities for investors: Options traders should consider a long straddle, which involves selling a put and call at the same strike price (perhaps 1.15), pocketing the premiums, and praying that the rate doesn’t fluctuate much (since they would be exposed to unlimited risk). In the future, carry traders can also profit from the lack of volatility through a carry trading strategy, perhaps amplified by a little leverage. Be careful, however. Since interest rate differentials are currently so small (The current LIBOR rate disparity is a mere .05%!) and probably won’t widen to more than 1% over the next twelve months, any profits from interest could easily be wiped out by even the smallest adverse exchange rate movements.

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Posted by Adam Kritzer | in British Pound, Euro | 2 Comments »

Euro Buoyed by Rate Hike Expectations, Despite Unresolved Debt Issues

Mar. 9th 2011

From trough to peak, the Euro has risen 9% over a period of only two months. You wouldn’t ordinarily expect to see this kind of appreciation from a G4 currency, especially not one whose member states are on the brink of insolvency and which itself faces threats to its very existence. In this case, the Euro is benefiting from expectations that the European Central Bank (ECB) will be among the first and most aggressive in hiking interest rates. As I warned in my previous post, however, those that focus solely on interest rate differentials and ignore the Euro’s lingering Sovereign debt crisis do so at their own peril.

Indications that the ECB will hike interest rates came out of nowhere. Jean-Claude Trichet, President of the ECB, announced last week that it would be particularly aggressive in taking steps to deal with inflation. This caught the markets by surprise, since Eurozone inflation is still below 2% and GDP growth is similarly low. Later, Governing Council members Mario Draghi and Axel Weber (both of whom are potential candidates to replace Trichet when he steps down later this year), issued similar statements, and the question of rate hikes was suddenly changed from If to When/How much.

Futures markets are currently pricing in 3 interest rate hikes, which would bring the Eurozone benchmark rate to 1.75% by year end. According to economist Nouriel Roubini’s (who gained fame by predicting the financial crisis) think tank: “Jean-Claude Trichet has been careful not to commit to a series of hikes, but we believe that is what it will be. The ECB is bluffing. We think the ECB will hike by a total of 75 basis points, probably by August.” Axel Weber, himself, coyly echoed this sentiment: “I see no reason at this stage to signal any dissent with how markets priced future policies.”

On the one hand, the recent rise in oil prices strengthens the case for rate hikes. On the other hand, the EU does not consume energy at the same intensity as the US, which means that its impact on inflation is likely to be muted. In addition, while the ECB’s mandate is indeed titled towards price stability (rather than boosting employment or spurring economic growth), to hike rates now would risk endangering the still-fragile Eurozone economic recovery. Unwinding its quantitative easing would similarly add to the risk of another financial crisis, since banks still make heavy use of its emergency lending facilities.

Speaking of which, it’s still way too early to say that the the EU sovereign debt crisis is behind us. Despite the loans and pledges and bailouts, interest rates for all four PIGS (Portugal, Ireland, Greece, Spain) countries continue to rise, and or nearing unsustainable levels. At the moment, currency investors have chosen to ignore this, since the EU has basically guaranteed them funding until 2013. What will happen then, or as the date draw near, is anyone’s guess.

In the end, one or more defaults seems inevitable. There is only so much that financial engineering can do to conceal and restructure debt which exceeds 100% of GDP in the cases of Greece and Ireland. If that were to happen, significant losses would be incurred by EU banks, which lent heavily to at-risk countries during the boom years. In order to minimize this situation, I think the ECB will probably continue to subsidize the banks via low interest rates.

Even if the ECB does hike rates, it will be extremely gradual. Furthermore, By the time Eurozone interest rates reach attractive levels, the other G4 Central Banks (with the exception of Japan) will probably already have started to close the gap. That means that interest rate differentials probably won’t soon be wide enough to lure more than a modicum of risk-averse investors. (Besides, if you assume a 5% chance of default, risk-adjusted rates are probably still negative).

In short, I think that the ongoing Euro rally is really just a short squeeze in disguise. Basically, speculators are conceding that shorting the Euro is both risky and unprofitable. (According to one hedge fund manager, “It was a very popular trade,” the portfolio manager says. A lot of us stuck with it, and it went wrong in January.”) In anticipating of higher future interest rates, they are preemptively moving to liquidate their short positions. However, not being short is not the same thing as going long. And until the EU sorts through the fiscal issues in a convincing way, I think it would be foolish to start making long-term bets on the Euro.

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Posted by Adam Kritzer | in Central Banks, Euro | 2 Comments »

Despite Recent Rise, Euro Still Looks Weak

Feb. 3rd 2011

As the Euro moves past $1.38 per Dollar towards a 1-year high, many traders are wondering if perhaps the common currency’s woes aren’t in the past. This would be a mistake. That’s because most of the forces behind the Euro’s rally actually have very little to do with the Euro.

The main cause of Euro strength has been a pickup in risk appetite. Investors are becoming increasingly more confident in the prospects for global economy recovery, and the crisis mentality is rapidly fading. Ironically, the flurry of positive economic data emanating from the US has been terrible for the Dollar. You can see from the chart below that except for a gap in 2010 Q4 (due to a flareup in the EU sovereign debt crisis….more on that below), the US stock market rally has coincided with a shift away from the Dollar and towards the Euro.

In fact, the Euro still remains extremely vulnerable to the ebb and flow of investor risk tolerance. That applies not only to events endogenous tot the EU, but also to global market shocks. That means that any reminder of the Eurozone’s fiscal issues (such as last week’s downgrade of Ireland’s credit rating) is likely to be reflected in a weaker Euro. For another example, look no further than the recent political turmoil in Egypt and the wider Middle East. Summarized one analyst, “In itself, Egypt is not that big an economy. But there is some worry about the supply of oil through the Suez Canal. It does impart a negative vibe on risk.”

The Euro’s recent appreciation is also rooted in technical factors. What began as a modest rally quickly turned into a upward surge as investors moved to cover their short positions. The WSJ reported that “much of the recent rally was fueled by hedge funds and other speculative investors covering short positions…Investors are ‘not going out and buying the euro because they love it.’ ” This apparent short squeeze can be seen in the sudden and massive reversal of positions that was documented in the most recent CFTC Commitment of Traders Report.

On a related note, there are signs that Euro puts (which allow investors to hedge Euro exposure by giving them the right to sell) are unusually cheap at the moment. “Demand for euro puts, which give investors the right to sell the euro in the future, appears to be growing, relative to euro calls, which allow them to buy, analysts say. That reverses a recent trend that had investors actively selling euro puts or sitting on their hands as the euro climbed…[and] suggests investors are becoming more biased towards selling the euro.” If speculators think that the options market is mis-pricing risk, they might start buying up puts and exert downward pressure on the Euro.

The only factor which could be construed as legitimately positive for the Euro pertains to interest rate differentials. Currently, Euro rates are just as low as in the US and the rest of the G4 world. However, that could soon change. The European Central Bank (ECB) is notoriously hawkish when it comes to conducting monetary policy. If you recall, it foolishly raised its benchmark interest rate during the height of the credit crisis. With inflation already running above 2%, you can bet that it will only be a matter of time before it reacts in kind. For the sake of contrast, consider that the Fed is still in the process of easing, via QE2.

While rate hikes would certainly provide a boost for the Euro, it is unlikely that rate differentials will be wide enough to spur any serious among yield-seeker in the immediate future. In short, I think the downside risks to the Euro (which is apparently on the verge of “disintegration,” according to George Soros) far outweigh any further upside support, and I think the rally will peter out soon.

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Posted by Adam Kritzer | in Euro | 4 Comments »

Euro: Which Investors Know Best?

Jan. 2nd 2011

As the WSJ recently pointed out, there is a bizarre disconnect between equities and currency markets regarding the Euro. On the one hand, the Euro was the world’s worst performing major currency in 2010, and some analysts insist that its breakup is inevitable. On the other hand, stock market investors are increasingly bullish about Europe: “We remain positive on the outlook for [European] stocks in 2011, with a favorable macro backdrop, solid earnings and attractive valuations.” Who’s right?

In fact, both sets of investors are justified. As you would expect, stock market investors are focusing on corporate earnings and the macroeconomic environment. In this regard, the fact that the EU economy expanded in 2010 – buoyed by a cheap currency and loose monetary policy – should certainly be reflected in a stronger stock prices. On the other hand, the sovereign debt crisis in EU has not yet abated, and accordingly, it is still being priced into EUR/ exchange rates.

In the immediate short-term, it’s possible that stock market investors will prevail and that that their collective view will be adopted by currency markets. According to Deutsche Bank, “The euro may rise to $1.45 by the end of the first quarter of next year, as concerns about the single-currency area’s indebted periphery diminish.” Meanwhile, China recently pledged its support for the Euro via a promise to purchase up to €5 Billion in Portuguese Sovereign debt. Over the short-term, then, it’s possible that (currency) investors can be persuaded to temporarily forget about the prospect of default, and focus instead on the Eurozone’s nascent economic recovery.

Over the medium-term, however, the markets will have no choice but to  return their attention to the possibility of default, which is why the same team of analysts from Deutsche Bank “forecasts the euro will fall back to $1.40 by the end of the second quarter and to $1.30 by the year-end.” For example, Eurozone members will need to issue more than €500bn in debt in 2011, including €400bn that needs to be refinanced by Spain and Italy. In this context, China’s purchases will fade to the point of becoming trivial.

Meanwhile, Moody’s has warned that it could follow up on its 5-notch downgrade of Ireland’s sovereign credit rating with further downgrades for Spain and Portugal. Fitch added that it might bump Greece’s rating to junk status, which would deal a significant blow to its solvency. Default is now rapidly on course to becoming a self-fulfilling prophecy, as fleeing investors cause yields to rise and credit ratings to fall, further scaring away more investors.

The EU response has been to “set up a permanent mechanism from mid-2013,” while investors continue to push for an expansion of the European Financial Stability Facility or the joint issuance of European sovereign bonds. As a result, the Center for Economics and Business Research has issued a striking forecast that there is an 80% probability that the European Monetary Union will dissolve over the next decade: “If the euro doesn’t break up, this could be the year when it weakens substantially towards parity with the dollar.” Already, spot market traders are once again increasing their short bets for the Euro, and options trading remains “skewed toward euro puts.”

To be fair, some analysts continue to insist that it is better to think of the sovereign debt problems as a crisis of credit, rather than of currency. In that sense, there is hope that a solution can be engineered (perhaps encompassing a default) that doesn’t endanger the existence of the Euro. In addition, the Euro finished 2010 on a high note, formally welcoming Estonia into the fold. It is 10% above its June trough, including a 2% rise in the month of December. Given all of the bad news in 2010, that might just be cause for optimism.

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Posted by Adam Kritzer | in Euro, News | No Comments »

Euro-Watchers Pull About-Face

Dec. 4th 2010

Only last month, the Euro was on top of the forex markets. Especially relative to its “G4” competitors (Dollar, Yen, Pound) – all of which are plagued by economic uncertainty and loose monetary policies – the Euro was seen as a smart bet. In the last few weeks, however, the EU sovereign debt crisis resurfaced, and the Euro has plunged, losing 7.5% of its value against the Dollar. As a result, investors have pulled an about-face: instead of banking on the European Central Bank (ECB) to buoy the Euro through monetary restraint, they are now counting on it to hold the Euro together by adopting the same tactics as its counterparts.

Before I explain what I mean here, I’d like to offer an update on the EU fiscal situation. In the last week, there were a handful of developments. First, Ireland accepted a tentative €85 Billion in aid from the EU/IMF, officially joining the ranks of an infamous club that also includes Greece. Still, it wasn’t clear whether such a bailout would also include Irish banks, which are seen as perhaps in deeper trouble than the Irish government. As a result, investors were unmoved, and S&P moved ahead with a cut to Ireland’s sovereign credit rating.

Ireland Public Deficit of GDP

Naturally, rumors began to circulate that Portugal was also preparing a formal bailout request. Said one trader, “In Portugal the kind of language you’re hearing is similar to what you heard in Ireland a few weeks ago.” Despite promises to the contrary, Portugal’s budget deficit has widened in 2010. Interest in its most recent bond issue was healthy, but at the highest interest rate since the Euro was introduced in 1999 and more than .5% higher than last month.

Ultimately, bailouts of Greece, Ireland, and Portugal can be managed. It is a default and/or preemptive rescue of Spain – the other PIGS member – that worries investors. Its economy represents more than 11% of the EU and any hiccup would seriously shake the foundations of the Euro: “It may well be that we are approaching the endgame of this part of the crisis as Spain is of such importance that one can only imagine that the EU will regard it as the line in the sand that cannot be crossed.” While Spain is working hard to cut its budget deficit to a still-stratospheric 9.3% in 2010, investors have balked. As a result, interest rates in its bonds have surged to a post-Euro high (relative to German bonds), and credit default swap spreads (which insure against the risk of default) have risen substantially.

The problem with the EU sovereign debt crisis – like most credit crises, for that matter – is that they tend to be self-fulfilling. As investors begin to doubt the ability of institutions (governmental and otherwise) to service their debts, they naturally demand greater compensation for the (perceived) increase in risk. This further inhibits that institution’s ability to repay its loans, which only makes funding more difficult to attract, and so on.

It is ironic on multiple levels then that even as investors abandon the debt of EU member countries, they are hoping that the ECB steps in to fill the void they create. As I alluded to the title of this post, this marks a stunning about-face from only a few months ago, when the Euro was rising against the Dollar because of the ECB’s commitment to a responsible monetary policy. Nowadays, the Euro rallies only on news that the ECB is maintaining or expanding its intervention. For example, the Irish banking sector is “increasingly more reliant on the ECB funding,” and as a result, “The euro edged up…as the European Central Bank continued buying Portuguese and Irish government bonds.”

Based on this change in investor mentality, it seems unlikely that the Euro will recover its losses anytime soon. Of course, the ECB has nearly unlimited resources at its disposal. German central bank chief Axel Weber declared confidently that, “An attack on the euro has no chance of succeeding.” However, the ECB can never hope to fully supplant the important role played by private capital, and besides, “What we are experiencing at present is not a speculative attack but a justified depreciation due to unsolved problems.”

Euro Dollar chart December 2010

There are still plenty of optimists who believe that the fear will soon die down and that higher interest rates will attract some of the yield-hungry investors that are currently focused on emerging markets. Goldman Sachs forecast “the euro will rise to $1.50 by year-end 2011 as big economies in the area continue expanding.”

I think the most realistic assessment is somewhere in between. On the one hand, it seems unlikely that the Spain will default on its debt at anytime in the near future or that the Euro will cease to exist. On the other hand, the fact that investors now see the ECB as a savior for following in the footsteps of the Fed implies that there is no reason for investors to buy the Euro against the US Dollar.

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Posted by Adam Kritzer | in Euro, News | 3 Comments »

Euro Correction is Here

Nov. 16th 2010

You can think of this as a follow-up to my last post, entitled “Euro Due for a Correction,” in which I proclaimed that “investors got ahead of themselves when they pushed the Euro down 20% over the first half of 2010, but now they are in danger of making the same mistake, and are pushing the Euro too far in the opposite direction.” Since then, the Euro has indeed fallen 4%. In this case, however, I’m reluctant to toot my own horn, since there were other forces at work.

Euro USD 3 Month ChartNamely, he sovereign debt crisis has officially spread beyond Greece, and “Contagion is definitely back on the table.”  Of chief concern is Ireland, whose banking sector is in serious financial turmoil: “Irish banking losses are estimated at up to 80 billion euros ($109 billion), depending on the forecast used, or 50 percent of the economy. As long as housing prices continue to fall, these losses cannot be capped.” At this point, it’s unlikely that the banks can remain afloat without (additional) government help. The only problem is that the government has already raided its welfare fund, and it is projected that additional support would leave a gaping hole in the budget, equivalent to 32% in GDP. Allowing the banks to fail, meanwhile, would lead to economic losses of 50% of GDP.

Portugal and Spain (rounding out the so-called PIGS countries) are also in trouble, with budget deficits of around 9% of GDP. Given that both countries are struggling economically, it is possible that austerity measures and budget cuts could backfire and worsen their respective fiscal situations. Like their Irish counterparts, Portuguese banks remain heavily reliant on access to cheap ECB credit in order to function. Spanish banks, meanwhile are plagued by distressed loans, which account for “5.6 percent of total Spanish bank loans — the highest level since 1996.”

Currently, their governments insist that they can get by without help from the European Commission. To be fair, they have managed both to issue new debt and refinance existing debt without serious difficulty. In addition, Ireland and Portugal have modest reserve funds which could tide them over for close to a year, if need be. The medium-term, however, looks less rosy.

Ireland Portufal Bond Yields 2010 - Sovereign Debt Crisis
If rising bond yields are any indication, these countries could be in serious trouble. Bond investors are not concerned about an EU bailout, which is seen as inevitable, at least for Ireland. After all, the European Financial Stability Facility that was created in May still has more than $500 Billion left in it. Rather, investors are concerned that they will be asked to take part in the bailout.

Germany, for example, is toughening its stance towards fiscally strained countries, and Angela Merkel has insisted that, “Highly indebted eurozone countries struggling to repay will be forced to restructure their debt in a process of ‘managed insolvency’ and that their creditors will need to take large ‘haircuts.’ ” Up until now, the EU has intimated that will provide a backstop against sovereign default, in order to assuage bond market investors.

This is changing, as German and French politicians insist that they are more beholden to their constituents/taxpayers than they are to their debt-ridden EU brethren.  Given that Germany is fiscally sound, it has pretty much nothing to lose (short of a breakup of the Euro) by playing hardball. In fact, it may actually benefit from scaring away investors, since a weaker Euro will strengthen its export sector.

Going forward, it seems safe to say that the Euro correction will continue, as investors continue to reevaluate their exposure to sovereign credit risk. According to the most recent CFTC Commitments of Traders report, “Investors last week slashed their bets in favor of the euro by 40% to a level not seen since early October.” Of course, given that the Dollar is plagued by its own set of problems, it’s unclear whether the EUR/USD will experience serious fluctuations. Against other currencies, however, the Euro will probably decline: “Those who want to go short euro should consider doing it on the crosses.”

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Posted by Adam Kritzer | in Euro, News | 1 Comment »

Euro Due for a Correction

Oct. 21st 2010

Since touching a four-year low in June, the Euro has risen a whopping 19% against the Dollar – a veritable surge! One has to wonder, however, if perhaps the Euro hasn’t gotten ahead of itself in its race back upward.

The Euro’s nonstop rise has perplexed me. During the throes of the Eurozone Sovereign debt crisis, it seemed as if the Euro was headed back towards parity, if it even remained in existence! The European Commission’s $500 Billion bailout plan seemed to assuage the markets, but didn’t do much to mitigate against the risk of sovereign default. Besides, it looks like all of the austerity measures will be undone after the next election cycle. Opposition to further budgets is so vehement, and unemployment is so high (12% in Greece, 20% in Spain) that it will be difficult for leaders to stay in office if they continue to push an agenda that reduces their deficits.

Euro Dollar 1 Year Chart

As evidence that bond investors remain skeptical, consider that Greek debt still trades at a 700 basis point premium to German bonds. EU cheerleaders love to point to the fact that at-risk Eurozone countries are having no trouble tapping the credit markets, but that’s not really surprising when you consider the lofty returns that investors receive for buying bonds that are essentially backed by the good credit of the EU.

Even ignoring the fiscal problems of the EU, the economic picture is not pretty. “The Economist Intelligence Unit, in its just-released report…is forecasting that growth in Western Europe will reach only 1.1% next year, and at or below 1.7% at least through 2015, beyond which it wisely declines to look.” When you subtract out Germany – the engine of the EU economy –  GDP growth will be even more pathetic. And don’t even mention the peripheral economies, many of which are at serious risk for sliding back into recession.

Moreover, the European Central Bank (ECB) monetary policy is just as loose as in other industrialized countries. Through its quantitative easing program, the ECB has injected hundreds of billions of Euros into the banking system and credit markets. Jean Claude Trichet, President of the ECB, bristled at the idea of ending this support: “No! This is not the position of the Governing Council, with an overwhelming majority.This non-standard measure…was designed to help restore a more normal functioning of our monetary policy transmission mechanism.”

On the other hand, the ECB is sterilizing all of its market intervention, which means that most of the funds that it is injected into the economy will remain in the EU. Contrast this with the Fed’s quantitative easing program (which hasn’t been sterilized) and you begin to understand why the Euro has held up well. In addition, Eurozone inflation currently exceeds US inflation (at a 50-year low), which means that the ECB will hesitate before following the Fed in easing monetary policy further.

Still, I don’t think there is a strong foundation for the Euro’s rise. It’s understandable that the expansion of the Fed’s quantitative easing program (“QE2”) is making investors nervous, causing them to send cash out of the US as a preventative measure. However, this seems a little too much like the tail wagging the dog, since until QE2 is officially implemented, all anticipatory shifts in capital flows are purely speculative – not fundamental. And as a fundamental analyst, that concerns me.

I think investors got ahead of themselves when they pushed the Euro down 20% over the first half of 2010, but now they are in danger of making the same mistake, and are pushing the Euro too far in the opposite direction. According to the most recent Commitment of Traders report, investors are building up long positions in the Euro, to the point that trading is becoming lopsided. I’m not much for short-term technical analysis, but when the Relative Strength Index (RSI) and Moving Average Convergence Divergence (MACD) are both approaching 2-year highs, it tells me that a correction is coming.

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Posted by Adam Kritzer | in Euro, News | No Comments »

Bullish on the Euro?

Sep. 29th 2010

Wouldn’t life just be a little easier if the EUR/USD, the most important forex pair and bellwether of currency markets, could simply pick a direction and stick to it. It dove during the financial crisis, only to surge during the apparent recovery phase, fell during the sovereign debt crisis, and rose during the paradigm shift, then fell as risk appetite waned, only to rise again in September, en route to a 5-month high.

Euro Dollar 5 Year Chart 2006-2010
There are a handful of factors which currently underlie the Euro’s strength, which can all generally be explained by the fact that risk is “on” at the moment, and the markets are moving away from so-called safe haven currencies and back towards growth investments. Of course that could change tomorrow (or even 5 minutes from now!), but at the moment, risk appetite is high and the Euro symbolizes risk. Never mind how ironic it is, that growth in the EU is projected at 1.8% for the year while Rest of World (ROW) GDP will probably top 5%. All that matters is compared to the Dollar (and Yen, Pound, Franc to a lesser extent) the Euro is perceived as the currency of risk.

The Euro’s cause is also helped by the ongoing “currency wars,” which heated up last week with Japan’s entry into the game. Basically, Central Banks around the world are now competing with each other to devalue their currencies. In contrast, the European Central Bank (ECB) has decided to remain on the sidelines (in favor of fiscal austerity), which is forcing the Euro up (or rather all other currencies down). To make matters even worse, “The U.S. Federal Reserve indicated this summer that it may ease monetary policy further… often seen as printing money to pump up the economy.” As a result, “The euro looks set to keep on climbing in a trend that looks increasingly entrenched.”

There are certainly those that argue that the Euro’s recent surge reflects renewed confidence in the Eurozone economy and prospects for resolving the EU debt crisis. After all, most Euro members will reduce their budget deficits in 2010 and auctions of new bonds are once again oversubscribed. On the other hand, interest rates for the PIGS (Portugal, Italy, Greece, and Spain) have risen to multi-year highs, as investors are finally trying to make a serious effort at pricing the possibility of default.

Eurozone sovereign debt interest rates graph 2007-2010
In addition, the credit markets in the EU are barely functioning, and large institutions remain dependent on the ECB’s credit facilities for financing. Finally, it shouldn’t be forgotten that the only reason crisis was due to the massive support (€140 Billion) extended to Greece. When this program expires in less than three years, the fiscal problems of Greece (and the other PIGS) will be exposed once again, and a new (stopgap) solution will need to be proposed.

As every analyst has pointed out, none of the EU’s fiscal problems have been solved. EU members have certainly proven adept at resolving acute crises and the ECB certainly deserves credit for keeping credit markets functioning, but none has proposed a viable solution for repairing of member countries’ fiscal and economic health. Currency devaluation is impossible. Sovereign default is being prevented. That leaves wage cuts and increased productivity as the only two paths to equilibrium. The former could be accomplished through inflation, but the ECB seems reluctant to allow this to happen.

Eurozone Budget Deficits, GDP

For better or worse, the EU seems to have pushed these problems down the road, and if all goes according to plan, they won’t need to be revisited for 2-3 years. For now, then, the Euro is probably safe, and may even thrive. Short positions in the Euro are being unwound with furious speed and data indicate that there is still plenty of scope for further unwinding. Inflation remains subdued, economic growth is stable, and the ECB so far hasn’t voiced any disapproval of the Euro’s rise. While I promote this bullishness with the caveat that “traders have shown a willingness to smack the euro lower from time to time on the slightest news or rumor of downgrades to euro-zone sovereign or bank ratings,” the general Euro trend is now unquestionably UP.

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Posted by Adam Kritzer | in Central Banks, Euro, News | 2 Comments »

SNB Leads Downward Pressure on Euro

Aug. 12th 2010

Since the beginning of this week, the Euro has retreated 3% against the US Dollar, including a 2% dip in Wednesday’s trading session, alone. Is it possible that the Euro rally was too good to be true, or is this correction only temporary?

euro USD 5 day chart
Earlier this week, Adam reported that China (via the institution that manages its foreign exchange reserves) was at least partially responsible for the Euro rally. If/when China desire to swap Dollars for Euros has been sated, the Euro rally could theoretically lose steam. At this point, it’s too early to call the end of the rally, since its steady appreciation has been marked by a handful of short-lived corrections. However, if this is indeed the start of a U-Turn, hindsight might show that it was inevitable that it would occur at this level.

As an aside, the kinds of back-and-forth swings that have become commonplace in forex markets may be attributable to large-scale investors, such as Central Banks. As currencies (or other securities, for that matter) decline, investors will often take advantage of low prices and enter the market. When prices rise, these same investors (joined by long-term investors) will often take profits and sell. As a result, it is hard for currencies to rally continuously without any kind of correction.

Back to the Euro, there are a handful of Central Banks who are making their presence known on this front. On several occasions over the last few weeks, the Central Bank of Switzerland (SNB) has unloaded massive quantities of Euros. If you recall, the SNB amassed nearly €200 Billion over the previous year, as part of a massive buying spree aimed at holding down the value of the Franc. Given that the Franc has appreciated by more than 15% against the Franc this year, it’s perhaps unsurprising that the SNB is throwing in the towel. (Oddly, it waited until Euros were cheap before it started selling).

EUR CHF 1 Year Chart

Analysts from Morgan Stanley foresees a similar trend: “Central banks are likely to let their euro holdings slide as a percentage of the total, reflecting lingering concerns about the euro zone’s fiscal outlook…’We do not expect that central banks will provide as much support for euros as in the past. They have prevented the euro from depreciating more rapidly… but they are unlikely to stop its depreciation.’ ” The implication is clear: the Euro is facing (passive) pressure on multiple fronts.

In fact, the kinds of back-and-forth swings that have become commonplace in forex markets may be attributable to large-scale investors, such as Central Banks. As currencies (or other securities, for that matter) decline, investors will often take advantage of low prices and enter the market. When prices rise, these same investors (joined by long-term investors) will often take profits and sell. As a result, it is hard for currencies to rally continuously without any kind of correction.

While it’s true that the average daily turnover of the global forex markets now exceeds $4 Trillion, the majority of this represents the rapid opening and closing of positions by the same group of traders. Only a small portion of this actually represents meaningful changes in portfolio allocation. Thus, when the SNB or the Central Bank of China buys or sells €15 Billion, it can seriously alter the course of the Euro, even though it would seem to represent an insubstantial portion of trading volume. Thus, market participants (especially amateurs) are advised to watch these market movers for signs of changes in their respective portfolios, because they will often signal the direction of the market.

For example, from 2002 to 2009, “The euro’s weighting in global reserves rose to 28% from 23%, according to International Monetary Fund data,” and over the same time period, the Euro rose 50% against the US Dollar. It’s possible that the Euro’s appreciation drove Central Bank purchases of the Euro, rather than the other way around. The truth is probably that the two trends reinforced each other. Given that Central Bank reserves are once again rising, any changes in portfolio allocation could have significant implications for the forex markets.

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Posted by Amy Cottrell | in Central Banks, Euro, News | 1 Comment »

China Currency Revaluation: More Than Just the Yuan at Stake

Aug. 9th 2010

I concluded my last post (Euro Recovery: Paradigm Shift Confirmed) by musing about how interesting it is that nobody has taken credit for predicting/profiting from the sudden reversal in forex markets, whereby the Euro has surged and the Dollar has tanked. Two days later, I think I can offer an explanation: China.

That’s right. The force behind the sudden sea change might not be private investors, which up until the spike entrenched itself as a full-fledged connection, remained firmly behind the declining Euro. Instead, it seems quite reasonable that China – via its sovereign wealth fund, which is charged with investing its foreign exchange reserves – might be the responsible party.

That China is buoying the Euro would make sense on a couple fronts. First of all, it would explain the mysterious silence behind the rally. China is naturally secretive in pretty much everything it does, especially in the way it conducts currency policy and manages its forex reserves. That China hasn’t even formally announced, let alone bragged about, “diversifying” its reserves, makes perfect sense.

More importantly, that China is responsible also makes sense from a strategic standpoint. China has long spoken about its intentions to change the allocation of its forex reserve holdings, and in hindsight, its timing was perfect. In the beginning of June, the Euro stood at a multi-year low, and the price of US Treasury Bonds stood at a multi-year high. Thus, China’s sovereign wealth fund was able to simultaneously lock in some profits from lending to the US and dissipate risk by swapping US assets for those denominated in Euros and Yen. “China has already bought $20 billion worth of yen financial assets this year, almost five times as much as it did in the previous five years combined.” [Analysts have noted that buying Yen also achieves the peripheral end of making Japanese exports less competitive relative to those from China].

Moreover, China can achieve this diversification without influencing the value of the Yuan, since Dollars can be exchanged directly for Yen and Euros. That is important, since the RMB is still effectively pegged to the Dollar. Speaking of which, the Yuan has hardly budged since its 1% revaluation in June. On a trade-weighted basis, it has actually fallen.

China's Current-Account Balance as a Share of GDP 2004-2015
Pressure continues to mount on China to allow the RMB to appreciate. As a result of the 1% nudge in June, speculative hot money is now flowing into China at an increasing rate, because investors are “thematically looking for ways that they can participate in the currency markets in China.” They are supported by the IMF, which most recently called on China to re-balance its economy away from exports and towards trade. Its report included predictions that China’s currency account / trade surplus will continue to rise, seemingly for as long as the RMB remains undervalued. Due to pressure from China, however, it removed precise figures on the recommended extent of said revaluation.

According to a consensus of analysts, China’s exports were probably lower in the month of July, which could give the Central Bank pause in allowing the RMB to rise too much too soon. Instead, it has announced that it will make a more sincere effort to tie the Yuan to a basket of currencies, rather than just the Dollar. ” ‘The yuan should be kept stable at a reasonable and balanced level overall, while it may have two-way moves against particular currencies,’ Hu [XiaoLian, Deputy Governor] said, adding that the composition of the central bank’s currency basket should be mainly based on trade weightings.”

USD CNY 3 Month Chart
Going forward, then, the Yuan will probably remain basically stable against the Dollar. As China moves towards a trade-weighted peg, however, it is conceivable that it will continue to buy Euros (and Yen, for spite) against the Dollar. As this could have a confounding effect on currency markets, traders should plan accordingly.

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Posted by Adam Kritzer | in Chinese Yuan (RMB), Euro, News | 5 Comments »

Euro Recovery: Paradigm Shift Confirmed

Aug. 7th 2010

In early July, when the Euro rally was (in hindsight) just getting under way, I reported on the apparent paradigm shift in forex markets, whereby risk-driven trades that benefited the Dollar were giving way to trades driven by fundamentals, which could conceivably favor the Euro. Since then, the Euro has continued to rally (bringing the total to 12% since the beginning of June), confirming the paradigm shift. Or so it would seem.

Euro fundamentals are indeed improving, with an improvement in the German IFO Index, which measures business sentiment, seen as a harbinger for recovery in the entire Eurozone economy. To be sure, Spain and Italy, two of the weakest members, registered positive growth in the most recent quarter. Contrast that with the situation across the Atlantic, where a growing body of analysts is calling for a double-dip recession with a side of deflation. The Fed has certainly embraced this possibility, and seems set to further entrench – if not expand – its quantitative easing program at its meeting next week.

eur USD 1 year chartAs a result, investors are rushing to reverse their short EUR/USD bets. What started as a minor correction – and inevitable backlash to the record short positions that had built up in April/May – has since turned into a flood. As a result, shorting the Dollar as part of a carry trade strategy is back in vogue. According to Pi Economics, “The dollar carry trade may now be worth more than $750bn, approaching the size of the yen carry trade at its peak in 2004-07.”

Naturally, all of the big banks were completely caught off guard, and are rushing to revise their forecasts, with UBS calling the Euro “exasperating” and HSBC comparing the USD/EUR to a “lunatic asylum.” An analyst at the Bank of New York summarized the frustration of Wall Street: ” ‘I’ll put my hands up on this—I have had a difficult time trying to call the market. The last time I remember it being this hard was in 2001 to 2002.’ ”

In this case, hindsight is 20/20, and if it wasn’t the stress tests that buoyed the Euro, it must be the acceptance that an outright sovereign default is unlikely. Personally, I’m not really sure what to think. There isn’t anyone who has come out to say I told you So, in the context of the Euro rally, which means it’s ultimately not clear who/what is driving it, and who is profting from it. In fact, you can recall that many hedge fund managers referred to shorting the Euro as the trade of the decade. It’s certainly possible that some of these investors took their profits from the Euro’s 20% depreciation in ran. It’s equally possible that investors are once again behaving irrationally.

The latter is supported by volatility levels which are gradually falling. Still, something smells fishy. A rally in the Euro only a few months after analysts were predicting its breakup is hard to fathom, even in these uncertain times. A columnist from the WSJ may have unwittingly hit the nail on the head, when he mused, “So, unless a European bank goes belly up or some other stink bomb explodes in the region’s debt markets, the old-fashioned relationship between [economic] data and currencies looks set to persist.”

To borrow his terminology, a stink bomb is probably inevitable. That’s not to say that investors aren’t focused on fundamentals; on the contrary, any stink bomb would probably directly harm the currency with which it is associated, rather than radiate through forex markets based on some convoluted sorting of risk . The only question is where the stink bomb will explode: the EU or the US?

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Posted by Adam Kritzer | in Euro, Investing & Trading, News, US Dollar | 4 Comments »

How About Those Stress Tests…

Jul. 27th 2010

What’s the deal with those stress tests? It sounds like the setup for a Jerry Seinfeld joke, and given the way the tests were viewed by the markets, it might as well have been. According to the EU, the tests were a tremendous success. According to investors, the results were irrelevant at best, and patently misleading at worst.

The stress tests were first proposed last month as a way to gauge the health of the EU banking sector; it was hoped that the results would demonstrate the soundness of the banking system and mollify investors. Since then, momentum continued to build in the markets, as investors engaged in meta-speculation about the potential impact of the stress tests.

In the days leading up to the test, there was a mixture of apprehension and uncertainty. One trader warned: “No one seems to want to hold too much risk heading into the release of the European bank stress tests….A great deal of caution should be exercised…as the results of the stress tests are made public. There is definitely the potential for a huge swing in either direction…as there could be a freight train coming down the tracks.” The Euro traded sideways, capping an impressive 8% rally that began in June.

Euro Dollar 3 month chart
On Monday, the tests were finally conducted: “EU regulators scrutinized 91 of the bloc’s banks to assess whether they have enough capital to withstand a recession and sovereign-debt crisis, with a Tier 1 capital ratio of 6 percent as a floor. Regulators tested portfolios of sovereign five-year bonds, assuming a loss of 23.1 percent on Greek debt, 12.3 percent on Spanish bonds, 14 percent on Portuguese bonds and 4.7 percent on German state debt.” Officially, only 7 banks failed the tests – 5 in Spain, 1 in Germany, 1 in Greece – with a combined capital shortfall of €3.5 Billion.

When the news was initially released, the Euro sea-sawed – first rising, then falling – and analysts rushed to ascribe sometimes-contradicting sentiments. First, there was “concern,” then came “relief.” From where I was sitting, the markets’ reaction was basically somewhere between a shrug and a yawn. First of all, investors saw the tests for the charade that they essentially were. The only reason that EU regulators were willing to conduct them publicly was because they knew that the results would be positive. As I wrote above, it was intended in advance that the tests would “mollify investors.”

On a related note, the tests were not nearly strict enough: “Analysts were instantly dismissive of the tests, saying the bar was too low. ‘The prospect of an outright sovereign default, which is what has worried markets most, has not even been considered.’ ”  Instead of examining the possibility of bonds becoming worthless and irredeemable, the tests only assumed modest losses.” By this standard, argue investors, it’s no wonder that virtually every bank was able to pass.

Ultimately, gauging the success of the stress tests will require waiting few weeks. Unlike currency, stock, and bond markets – which can and did offer instant feedback on the news – it will probably take some time before the impact is fully reflected in the money markets. In other words, while an uptick in the Euro, shares of bank stocks, and sovereign bond prices should all be seen as symbols of confidence, the real test is whether investors will be willing to lend directly to banks, at reasonable rates (proxied by 3-month Euro LIBOR, on display below).

3-month EURO LIBOR 2006-2010
In fact, that test could come quite soon, as the ECB continues to recall the hundreds of Billions of Euros in loans that it made to commercial banks. If LIBOR rates remain steady and the markets remain liquid, then the stress tests can be called a success. If private investors balk and/or the ECB is forced to extend its lending program, however, the tests will be seen in hindsight as a waste of time.

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Posted by Adam Kritzer | in Central Banks, Euro, News | No Comments »

Euro Rally: Temporary or Permanent?

Jul. 17th 2010

Since the beginning of June, the Euro has rallied by an impressive 8% against the US Dollar, and by comparable margins against other currencies. The question on every one’s minds, of course, is whether this represents a temporary pullback or a permanent correction.

EUR USD 3 months 2010
The arguments in favor of the former are pretty strong. Namely, EUR/USD bearish sentiment had expanded to such an extreme level that a pullback – temporary or permanent – was basically inevitable. From this standpoint, what we have seen unfold over the last month-and-a-half is a classic short squeeze. Basically, those who were short the Euro were forced to cover their positions when it started to rally, which in turn triggered more selling, and ultimately, a self-fulfilling rally. As a result, “The difference in the number of wagers by hedge funds and other large speculators on a decline in the euro compared with those on a gain dropped to 38,909 on July 6, compared with record net shorts of 113,890 on May 11.”

Due to its sudden rise, the Euro became a much less attractive funding currency for carry traders. It helps that other Central Banks are delaying interest rate hikes, which means it’s difficult to turn a solid profit (on a risk-adjusted basis) from shorting the Euro. In addition, the markets have started to turn their attention to economic fundamentals in the US, which had been edging out the Euro in one of the perennially important rivalries in currency markets. In short, it suddenly became obvious to traders that the economic and fiscal conditions in the US are at best equal to those in the EU.

Finally, there was an implicit acknowledgement among the EU leadership that the so-called sovereign debt crisis is actually in many ways a banking crisis. This admission came in the form of stress-tests on 91 of the EU’s largest banks, designed to determine their exposure to sovereign debt and placate investors. After all,  “It was German and French banks that led the way in lending to Greece or Spain.” This misjudgement has spurred such banks to set aside Billions in potential losses and vastly curtail their lending activities.

Unfortunately, investors are skeptical that the stress tests will be stringent enough, seeing them as a mere publicity stunt: “While the EU have tried to counter these suspicions by promising to publish the result of stress tests, the market is fearful that stress tests will force some banks into writing down losses on non-performing loans.” By extension, investors are still equally concerned about the possibility of a sovereign debt default, even one that it is only partial.

In other words, the consensus is that despite the EU’s best efforts to tackle the crisis, it still has yet to enact meaningful structural reforms, opting instead for short-term stopgap solutions. According to The Economist, “The debate about how to save Europe’s single currency from disintegration is stuck…because the euro zone’s dominant powers, France and Germany, agree on the need for greater harmonisation within the euro zone, but disagree about what to harmonise.” There remains a lack of agreement over whether the economically and fiscally weaker members of the EU will be allowed to remain members, and if so, what if anything will be done to keep them in line.

EU Public Debt

As you can see from the chart above, time is quickly running out. For the majority of EU countries, debt is now rising faster than GDP. From the standpoint of many investors, default seems like the most likely outcome since such countries lack the political muster to reduce their budget deficits, nor can they devalue their debt  through currency depreciation, due to the common currency.

Thus, the consensus (for now) is that the Euro’s run will soon come to an end. According to Citigroup, “The euro will resume its decline and head toward the $1.10-$1.15 range. ‘The market has digested a lot of the bad news about the euro. There’s no great optimism.’ ” Meanwhile, BNP Paribas “expects the euro to fall to parity by the end of 2010—one euro per dollar—a level it hasn’t seen since December 2002…[and] drift to 97 cents before hitting bottom in the third quarter of 2011.”

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US Dollar Paradigm Shift

Jul. 7th 2010

Since the inception of the financial crisis, the Dollar has been treated as a safe haven currency. Simply, when there was a surge in the level of risk-aversion, the Dollar rose proportionally. When risk aversion gave way to risk appetite, the Dollar fell. It was as simple as that.

Lately, this notion has manifested itself in the EUR/USD exchange rate, with the Euro embodying risk, and the Dollar embodying safety. In fact, a carry trading strategy has unfolded along these lines and made this phenomenon self-fulfilling: traders have taken to reflexively selling the Dollar when news is good and selling the Euro when news is bad.

EUR USD July 2010

In recent weeks, this approach appears to be changing. It started with the US stock market, which began to decline, even as the Dollar was still rising. Investors had started to worry about the housing market stalling, the exhaustion of the government stimulus effect, and worst of all, the possibility of a double-dip recession. The most recent data “showed U.S. gross domestic product in the first quarter grew more slowly than expected…The U.S. GDP numbers came after some weaker-than-expected housing numbers and a dovish Federal Reserve, all of which drove U.S. Treasury yields lower and prompted investors to reassess their dollar positions.”

From my point of view, it is not the possibility of a prolonged recession that is itself noteworthy (though this is surely cause for concern), but rather that the currency markets are paying attention it. To be sure, news of the EU sovereign debt crisis continues to dominate headlines and influence investor psychology. Barring any unforeseen developments, however, this crisis probably won’t evolve much further in the short-term, and it’s logical that investors should turn their attention back to the data.

As a result, “The popular risk-related trade on the euro ‘that was prevalent in the first half of this year appears to have derailed for the time being as market players increasingly focus on comparative fundamentals once again,” summarized one trader. In fact, the Dollar has fallen by 5% over the last month, both against the Euro and on a trade-weighted basis.

DXY 2010

Over the long-term, analysts are divided over which narrative will determine the EUR/USD rate. It would seem that until there is some resolution to the sovereign debt crisis (whether positive or negative), an air of uncertainty will continue to hang over the Euro such that it remains an apt funding currency for a carry trade strategy. US capital markets are the world’s deepest, most liquid, and most stable, and in times of crisis will probably continue to attract risk-averse capital.

On the other side are those who argue that the US will shed its safe-haven status and become a growth currency. According to this line of thinking, the US economy will outperform the EU, Japan, and Britain – its peers/competitors in the Top Tier of currencies.
“The euro zone has been stricken by crisis over the debts of its weaker members. Japan will only emerge slowly from deflation and the U.K. has to deal with its record high budget deficit over the next few years,” argued one analyst.

As a result, “The dollar will return to a pattern seen in the early 1980s and late 1990s, when it appreciated as stocks rose…The likelihood that the dollar performs strongly rather than weakly when investors are risk-seeking will signify a major change in the currency markets.” Under this paradigm, the Japanese Yen and the Swiss Franc would probably become even further entrenched as safe-haven currencies.

Finally, it’s worth pointing out that such a paradigm shift wouldn’t necessarily be good for the Dollar. If the US is indeed able to put the recession behind it, then a renewed focus on growth fundamentals would send the Dollar higher. If the Double-Dip materializes, however, Dollar bulls will probably find themselves hoping that the Dollar can retain its safe haven status.

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“Investors” Shouldn’t Worry about the Euro

Jun. 26th 2010

With today’s post, I want to take off my currency trader hat and put on my investor hat.

You might be tempted to argue: But wait, these two aren’t mutually exclusive. Isn’t it possible to wear both hats? While it’s theoretically plausible for a trader to take a long-term view of the markets based on fundamental analysis, I don’t think it’s likely in practice. In the end, a good investor will always have a longer time horizon than a good currency trader. In short, someone who bought shares in Apple 20 years ago is now probably a millionaire. Someone who went long the USD 20 years ago has probably since lost his investment due to inflation.

But seriously, currency traders must adapt to the zero-sum nature of forex markets by shortening their time horizon. Stock market investors, on the other hand, are not bound by this constraint. In fact, by holding stocks for a long enough time period, investors can actually turn this into an advantage.

As a result of the Eurozone sovereign debt crisis, for example, some analysts are calling for foreign (i.e. not using Euros) investors to dump their European. investments. This recommendation is not necessarily a dismissal of European companies (though an argument could be made on this basis as well), but rather is a reflection of concerns that returns will be negatively impacted by the declining Euro. Since foreigners can only purchase shares using their home currencies indirectly (through ADRs and ETFs), they feel the effects of currency fluctuations every time they enter and exit a position. Those that entered into a position prior to the Euro’s decline, by extension, will naturally be hurt if they try to exit before the Euro has had a chance to recover.

But therein lies the problem with this approach. Those that dump their shares now solely over exchange rate concerns are simply locking in their losses, just like American stock market investors who sold their stocks in March 2009 when the DJIA was below 7,000. By instead waiting a year (or longer!) such investors could have at least partially neutralized the impact of these crises. Of course, if recovery in the Euro was perceived as inevitable, then portfolio investors naturally wouldn’t think about divesting from EU capital markets. The concern is that the Euro will continue to decline, perhaps to the point of breakup.

I don’t want to dig myself into a hole by making a 5-year prediction for the Euro, especially since there is a part of me that is concerned that it will continue to decline. Based on history, however, there is very little reason to believe that will be the case. I’m not talking about economic fundamentals – about how the US fiscal position is equally precarious and how currency markets might recognize this and turn on the Dollar – but rather about the nature of forex markets.

Euro Dollar 5 Year Chart 2005-2010

Simply, currencies fluctuate. Since its introduction 10 years ago, the Euro has fallen, then risen, then fallen, then risen, then fallen again to its current level. If you initially invested in Europe 2 years ago, the exchange rate would erode your returns if you tried to sell now. If you invested 5 years ago, you would break even. If you invested 10 years ago, you would come out ahead. In the end, it’s only a question of perspective. Still, if you maintain your positions for long enough, either you will break-even from the exchange rate or it will only marginally affect your returns (on an annualized basis).

Consider also that you can hedge your exposure to a falling Euro by simply buying Dollars. If you are concerned about exchange rate risk, you can do this every time you open a position. For example, if you were to buy European shares today and simultaneously short an equal quantity of Euros, you would be perfectly hedged against any further decline in the Euro. The cost of the hedge is the sum of any transaction costs, management fees, and negative carry that you incur as part of the currency trade.

In short, unless you deliberately want to speculate on exchange rates, don’t worry about them! If your investing horizon is long enough, their fluctuations will neither help nor hurt you in a meaningful way.

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Posted by Adam Kritzer | in Euro, Investing & Trading, News | 8 Comments »

Euro Rally only Temporary

Jun. 19th 2010

Something incredible has happened: The Euro has reversed is 16.5% decline (from peak to trough), and since bottoming on June 7 at $1.1876, it has risen by an impressive 4%. I guess that means the Euro has been rescued from parity (which I characterized as “inevitable” on June 5)?

EUR USD 3 Month Chart
Not exactly. While financial journalists have interpreted this as a recovery in risk appetite, and mainstream investors dismiss all of it as mundane fluctuations in exchange rates, currency traders – both fundamental and technical – know better. They know that this rally is merely a correction, the product of the Euro falling too much too fast against the Dollar and a consequent short-squeeze. They know that there is nothing underpinning the Euro rally, and that since the bad news continues to emanate from the Eurozone, a further decline is inevitable. ” ‘We could be one or two headlines away from a crisis again. This problem didn’t occur in a couple of days, nor is it going to resolve itself in a couple of days,’ ” summarized one trader.

According to Brown Brothers Harriman, ” ‘The recent euro rally is a corrective phase in a bear market and not a change in trend.’ National Bank Financial added, ” ‘Ultimately, when the market is this short a particular currency and a pullback happens, it results in some price volatility. It doesn’t necessarily reverse the longer-term trend.’ ” Given that so-called net-short bets against the Euro rose to a near record high in the beginning of June, it was inevitable [to borrow my favor word of the moment] that traders would eventually “cut positions when momentum in a currency [the Euro] shifted.”

From a fundamental standpoint, the last two weeks have brought further indications that the crisis is still mounting. The credit rating on Greek sovereign debt was cut to junk (A3) by Moody’s, following a similar move by S&P in the spring. Fitch, while arguing that the Euro has already declined “too far” is simultaneously threatening to do the same.

Meanwhile, Spain managed a successful debt auction, but at interest rates nearly 1.5x what it had to pay the last time around. Still, it’s in a more favorable position than Greece, which is now paying a yield premium of more than 600 basis points on its debt, compared to Germany. The implications for currency markets are clear enough: “There is a little bit of a disjuncture between what the currency is doing and what these bond markets are doing, and that’s a problem for the euro.”

Politicians, for their part, are still struggling to convince investors that they are serious about trimming their budgets and uniting for the sake of the Euro. “I see good news from the current euro-dollar rate, French Prime Minister Francois Fillon told reporters…’and I have been saying for years that the euro-dollar rate didn’t reflect reality and was penalizing our exports.’ ” With comments like that, is there any cause for believing them?!

Even putting politics and economics aside, there is a force that will continue to punish the Euro regardless of what happens: the carry trade. According to the WSJ, there is “some evidence that investors are indeed using euros to finance their bets. That is important because it means there may be structural reasons in the investment world why any lift in the euro will simply be quashed.” Thanks to the promise of continued low interest rates and confidence in its decline, ” ‘The euro is the clear-cut funding currency of choice.’ ”

At this point, then, the only issue is when the Euro will resume its decline. Those with a technical bend think that the Euro will fail to breach a psychologically important level (perhaps $1.25 or $1.27) after exhausting the rest of its momentum, at which point it will resume its precipitous decline. Those who see things in fundamental terms argue that when this happens, it will likely be due to more bad news about the crisis and/or a recovery in risk appetite (the contradiction between the two notwithstanding).

Rest assured, Euro bears. Your friend, the trend, is still intact.

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EUR/USD: The Next Benchmark is Parity

Jun. 5th 2010

The Euro has now declined for six consecutive months against the Dollar. It is down 25% from its 2008 high and 15% in the year-to-date. It declined 8% in the month of May alone. En route to a four year low, the Euro also fell below the 50% retracement level ($1.21) of its rally from 2000-2008. It’s now too clear where the Euro is headed: parity.

eur usd 1 year chart
That’s right. Parity. We’re not talking about the Canadian Dollar or even the Australian Dollar. We’re talking about the Euro, which only yesterday was trading at a lofty $1.60 against the Dollar. According to CLSA Asia Pacific Markets, “The euro will sooner or later go to parity with the U.S. dollar.” Meanwhile, “The research firm Capital Economics predicts that the euro will reach par with the U.S. dollar by the end of next year.” There wasn’t even a perfunctory attempt by either firm to justify the prediction. Given the way that the Euro has been trading, it probably wasn’t necessary.

Since the last time I reported on the Euro, the bad news has continued to pour in. Spain officially lost its AAA credit rating, and concerns are mounting that the crisis is spreading to Hungary (not even on the radar screen last week) and Italy: “While Italy may not be as structurally vulnerable as Greece or Portugal, the relative underperformance of Italian credit default swaps this month suggests that investor concerns may be rotating away from Greece.” As if it wasn’t bad enough that investors had lost confidence, now banks won’t even lend to each other.

The $1 Trillion bailout, meanwhile, has done nothing to assuage the markets. “The markets are trading in real time, while the politicians are moving in bureaucratic time. We’re promised something maybe in October — that’s a hell of a long time in the financial markets’ eyes,” underscored one economist. Germany appears to be isolating itself from the rest of the EU, thanks to its ban on the short-selling of certain financial movements- a move that was not matched by other member states. “Concerns are also growing because Belgium is unlikely to have a government in place when it takes over the EU presidency on July 1 and markets are worried the EU’s institutions and leaders are ill-equipped to handle a crisis of this magnitude.”

The main issue, which critics of the bailout have been quick to point out all along, is that the fiscal problems that precipitated the crisis are still extant. Spain, for example, currently has the third largest budget deficit in the EU, and yet, it is struggling to make meaningful cuts and pass the necessary “austerity measures.” Germany has tried to unilaterally amend the EU treaty in order to force member states to balance their budgets, but to no avail. If a full-blown crisis is to be avoided, significant structural reforms will have to implemented, and soon.

For many, that the crisis will not be resolved is a foregone conclusion, and they have instead embraced the possibility of ECB intervention to stem the Euro’s decline. The last time the ECB intervened was in 2000, shortly after the Euro was introduced and when it was trading around 87 cents to the Dollar. Experts are divided over whether intervention is likely or even possible. Some have thrown out $1.10 or $1.00 has hypothetical levels at which the intervention would be likely, but the fact of the matter is, no one knows. Any intervention would necessarily involve the Fed and the other important Central Banks of the world. Don’t forget that when the Euro collapsed at the onset of the credit crisis, the Fed quickly underwrote a series of swaps to the ECB, and it could prove to be a willing participant this time around.

Recent History of Currency Intervention- Dollar, Euro, Yen

The ECB is naturally being coy, with President Jeane-Claud Trichet declaring: “Let us be clear, it is not the euro that is in danger.” Its monetary policy is still extremely accommodative, via low interest rates and a form of quantitative easing. This makes it favorable for investors to bet against the Euro, and is starting to earn the ECB the ire of EU politicians and economic policymakers. Given that the Euro’s decline has become self-fulfilling, pressure on the ECB will continue to mount, until the Euro reaches parity, and/or it has no choice but to intervene to prevent the common currency (and its raison d’etre!) from collapsing entirely.

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Posted by Adam Kritzer | in Central Banks, Euro, News | 4 Comments »

When Will Attention Shift to the Dollar?

May. 16th 2010

The fiscal crisis ravaging the Euro and the Pound has sent the Dollar skyward. On the one hand, the prospect of continued uncertainty and dissolution of the Euro would seem to be an excellent harbinger for continued appreciation in the Dollar. On the other hand, it should only be a matter of time before investors recognize that the Dollar’s fiscal fundamentals are also quite weak.


Unlike during the last few years, analysts are no longer talking about (forex reserve) diversification. It was once widely predicted that the Euro would rival the Dollar for a place in the portfolios of foreign Central Banks. As expected, preferences are now shifting back in favor of the Dollar and to a lesser extent, the Yen. The Pound and Swiss Franc may have a small role, as will the “New” Euro. Over the short-term, however, Central Banks (and investors) will continue to eschew the Euro, if only due to sheer uncertainty.

Given that everything is relative in forex, investors and Central Banks only have so many options when it comes to choosing which currencies in which to denominate their portfolios. Thus, it’s understandable that a sudden crisis in the EU would buoy the Dollar. At the same time, it’s not exactly a good bet that the US isn’t destined to suffer a similar fate.

Due to extremely low short-term interest rates, most investors have been willing to accept low returns when lending to the US (by buying Treasury Securities, and indirectly by simply holding Dollars). At some point, both short-term interest rates and the rate of inflation will rise, and investors will have to re-examine their risk/reward schemes. My suspicion is that investors will demand higher yields in exchange for lending to the US.

Just like with Greece, a US fiscal crisis would probably emerge suddenly. While the US government pays lip service to the notion of balancing its budget and reducing its sovereign debt, even the most optimistic projections show a budget deficit for the next 10 years. Beyond that, the retirement of the baby boom generation and their “entitlement” payment will make it nearly impossible for the US to operate a budget surplus.

In short, the only hope is for the US economy to grow faster than the national debt. If the US economy grows at 4% per year, for example, it will have to run a budget deficit less than 4% of GDP in order to reduce its relative level of debt. On the surface, this seems like a reasonable possibility, but given trends over the last three decades (covering periods of both recession and economic boom), it doesn’t seem likely.

This is not new information. Doomsday theorists have been predicting the bankruptcy of the US for two centuries. Don’t mistake me for doing the same. Rather, I only wish to point out how ironic it is that the Dollar’s fiscal conditions are comparable (and in some ways worse) than some of the problem countries that investors are currently focusing on.

Then again, forex is relative. Some analysts have suggested that the new reserve currency will be gold, oil, and other commodities. Unfortunately, there isn’t nearly enough (liquid) supply of these materials to occupy more than a small portion of reserves. Under the current system, then, investors are pretty much stuck with the Dollar. At this point, betting to the contrary is tantamount to betting on the complete collapse of the modern financial system. A reasonable bet, perhaps, but you can forgive investors for being hesitant to embrace it.

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Euro Still Doomed, Despite Bailout

May. 12th 2010

In my last post, I reported that the markets were incredibly bearish on the Euro, due to concerns that the Greek debt crisis could neither be mitigated nor contained. By following up on this report with another incantation of Euro bearishness, I certainly run the risk of belaboring the point. Still, the fact that since then, a $1 Trillion bailout was announced means that at the very least, I need to offer an update!

Anyway, in case you have been living in a cave, the EU finally put its money where its mouth was by forming a €750 Billion Special Purpose Vehicle (SPV) to address the fiscal problems of currently-ailing and potentially-ailing economies. The brunt of financing the SPV will fall on individual Eurozone countries, though the European Commission and the International Monetary Fund (IMF) will also make sizable contributions. In addition, the European Central Bank (ECB) has agreed to purchase an indeterminate amount of government and corporate bonds, while other Central Banks will use currency swaps to ease pressure on the Euro.

EU IMF Euro Bailout - Two Pronged Approach

The reaction to the news was quite positive, with the Euro reversing its 6-month slump and rallying 2.7% against the Dollar. Equity shares surged on the news: “A a 50-stock mix of European stocks jumped 10.4 percent, Spain’s market soared 14.4 percent, France’s rose 9.7 percent and Germany’s gained 5.3 percent.” Sovereign debt and credit default swap prices also rose as investors moved to price in a decreased likelihood of default.

The celebration was short-lived, and by Tuesday (yesterday), the Euro had already returned to its pre-bailout level against the Dollar. In hindsight, it looks like the rally was the result of a classic short-squeeze. On Sunday, the Financial Times reported that “Positioning data from the Chicago Mercantile Exchange, often used as a proxy for hedge fund activity, showed speculato,rs increased their short positions in the euro to a record 103,400 contracts, or $16.8bn in the week ending May 4.” After the most exposed short positions were covered, however, the rally quickly came to an end: “By the time markets opened in the United States, and American hedge funds entered the market, the euro’s rally began to flag.”

Euro 5 day chart
Indeed, it’s hard to find anyone that has anything positive to say about the bailout, even among the bureaucrats and politicians that contrived it. Here’s a smattering of soundbites:

  • “Angela Merkel, the Iron Chancellor, has rolled over and we are being taken to the cleaners.”
  • “We’ve just kind of kicked the can down the road. Sovereign debt, like all debt, ultimately has to be repaid.”
  • “The bailout is ‘another nail in the coffin…This means that they’ve given up on the euro.”
  • “Lending more money to already overborrowed governments does not solve their problems.”
  • “It was crucial to stop the panic, and this package has done it, but it doesn’t solve the longer-term problems which are slowly undermining the value of the euro.”
  • “It’s pretty disappointing that [the] euro only rallied a couple of cents on the back of a trillion dollars.”

There are a few specific concerns about the bailout. First of all, it’s still unclear how it will be paid for and how it will be implemented. How will specific loans be issued, and what will be the accompanying terms? Second, it does nothing to address the underlying fiscal problems that precipitated the crisis, and may in fact exacerbate them since countries have less of an incentive to rein in spending. As one analyst summarized, “Bailing out economies creates moral hazard. Other countries may continue to skirt the kinds of actions that would lower their budget deficits and debt loads…because they too can expect to be rescued.” Finally, the bailout does nothing to mitigate credit risk for private lenders; it merely transfers and expands it, since money that would have been lent to Greece (and other problem countries) anyway, will still be lent to them, after first being funneled through the SPV. In short, “Once market participants look at the actual details of this plan, they are not going to want to buy the euro either.”

As everyone has been quick to point out, the bailout probably makes a (partial) dissolution of the Euro even more likely, because it is tantamount to deflating the currency. As one economist opined, “The euro zone does not look viable in its current form. The basic premise…to unify monetary policy….while keeping fiscal policy completely separate…has completely broken down.” The only solution which will leave the Euro intact is for the weakest members to leave, and for a solid core of economically and fiscally sound economies to remain behind.

To be fair, the EU has certainly bought itself some time. Given that the amount of money pledged to fight the debt crisis well exceeds Greece’s public debt, it won’t be Greece that brings down the Euro. If/when the debt problems of Spain, Portugal, and Ireland become insoluble, however, the futility of the bailout will become abundantly clear.

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Greek Debt Crisis Widens

May. 6th 2010

I must confess: I never expected the Greek debt crisis to reach such a dire threshold in such a short time period. Over a matter of mere months, the Euro has fallen 15% against the Dollar. That’s the kind of drop that you would have expected from the Greek Drachma, not from the Euro!

5y Euro

Moreover, it’s not as if this slide is anywhere close to abating. “I don’t think you’d want to bet on a bottom, at this stage, in euro. We’re headed closer to $1.2000 at some point in the game. It’s just a question of when,” said one prominent analyst. Meanwhile, net shorts against the Euro have reached a record 89,000 contracts, according to the weekly Commitments of Traders report. What is producing this swell of bearish sentiment, which is causing the markets to trade in a manner best described as “panic mode?”

The answer, it seems, is a self-fulfilling belief not only that Greece will default on its debt, but also that the credit crisis will spread to the rest of Europe. Greek interest rates recently topped 8%, and the spread with comparable German bonds (this spread has become a crude way of gauging the seriousness of the crisis) is close to an all-time record. Credit default swaps, which insure against the risk of default, surged to 674 bas points, reflecting a 15% probability of default. Meanwhile, credit default swap spreads on Spanish and Portuguese debt is also creeping up.

At this point, there seems to be very little that Greece can do to mitigate the crisis. It has already announced a series of austerity measures, including wage cuts and tax hikes, designed to narrow its budget deficit. In addition, it has successfully obtained an aid package from the EU and IMF, valued at $160 Billion. In April, it successfully refinanced $12 Billion in debt, even though experts insisted that such would be very difficult, given current investor sentiment.

On the other hand, the austerity measures were met with riots, which left 3 people dead, and signaled that the Greek citizenry would sooner vote out the incumbent government than accept their proposals to reduce the budget deficit. Speaking of which, under the best case scenario, the deficit will decline to a still-whopping 8% of GDP in 2010 (from a revised 13% in 2009), and Greece’s budget will remain in the red until at least 2014, by which point its gross national debt is projected to have reached 140% of GDP. Of course, this assumes that GDP growth will turn positive in 2012, and this is no guarantee. Meanwhile, the aid package will probably be enough to tide Greece over for only about 18 months, after which point it will have to return to the capital markets. Even before it can tap the bailout, it must first refinance another $10 Billion in debt in May.

Europe's Web of Debt

In other words, even if Greece can forestall default for 2010 and 2011, who’s to say that it won’t default in 2012? With this possibility in mind, it makes it very unlikely that investors will continue to buy Greek bonds at all, let alone at affordable interest rates. “People are becoming well aware of the fact that the solvency issue for Greece hasn’t been resolved with the aid package. They still have to repay the money. They still have to repay the interest.”

Finally, there is the risk that the crisis will spread to the rest of Europe. Both the IMF and the Spanish government have been busy refuting rumors that Spain is seeking a similar bailout. Regardless of its veracity, the fact that such a rumor even exists will be enough to make investors sweat. When investors get nervous, they stop buying government bonds and/or demanding higher interest rates, which ironically only makes it more likely that the government in question will default. Fortunately, it seems that Spain (and its neighbor, Portugal) are in strong enough shape that they could survive a sudden speculative attack from investors.

Greece, however, is basically a lost cause. “Greece is functionally bankrupt,” and the only solution is for it to leave the Euro and/or default. Until that day comes, uncertainty will persist, and investors will continue to doubt the Euro.

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Greece Weighs on the Euro…Still

Apr. 23rd 2010

This has really become the story that simply won’t go away. Just when it seemed investors had fully digested the implications of the Greek debt crisis, they once again turned their attention to it and attacked the Euro with renewed vigor. Summarized one analyst, “Fears regarding Greece have been reignited.” As a result, the Euro is already down nearly 10% on the year, and we are barely into the second quarter!

Euro Dollar 1 year
Since I last posted on this issue, there have been a handful of key developments, the most important of which was the approval of an emergency loan packaged. Under the terms of the agreement, the EU will lend €30 Billion to Greece, and the IMF will lend an additional €15 Billion. Both loans will have 3-year terms and 5% coupons. While George Papaconstantinou, Finance Minister of Greece, “insisted that this was ‘not tantamount’ to asking for a bailout,” the markets were of the opposite mindset, which is why the Euro immediately advanced 1.5% when news of the loan package broke on April 12.

Since then, the Euro has cooled, the Greek stock market has dropped, and borrowing costs have surged: “The spread between the government’s 10-year bonds and benchmark German debt [has risen] to 549 basis points, the highest in at least 12 years. Credit- default swaps tied to Greece’s debt jumped 149 basis points to a record 635.” What happened?!

It seems that despite the assurances of Eurozone countries that “parliamentary approval would take ‘one week or two weeks at the maximum’ ” and analysts’ assertions that “Greece is as close to activating the rescue package as one can imagine,” the markets were simply not convinced. Some EU member countries have warned that “new legislation” will be required to lend money to Greece and “a group of German professors are readying a challenge to the rescue plan in Germany’s constitutional court.” In short, until Greece has the money in hand, nothing can be taken for granted. In addition, Greece must refinance €8 Billion in short-term debt that expires on May 19, and investors are skeptical that it can do so at tolerable interest rates, if at all. For example, a US Dollar-denominated bond offering that was projected to bring in $5-10 Billion attracted only $1-4 Billion in institutional interest.

Of course, there is also the concern that even if Greece can raise enough short-term cash to remain solvent, it will once again face trouble in the medium term: “An infusion of cash won’t fix Greece’s long-term problems, and the ‘only choice’ for Greece could be a ‘dramatic economic contraction,’ ” said one expert.Even if default wasn’t previously inevitable, it is quickly becoming self-fulfilling, since investors’ nervousness is leading to higher interest rates (aka borrowing costs), which is making it more difficult for Greece to reduce its budget deficit, which will cause investors to become more nervous, etc etc.

Unsurprisingly, experts have begun to look at alternative scenarios, such as leaving the Euro. The consensus is that it would be mechanically and legally feasible, but economically catastrophic. It would result in massive currency devaluation and economic recession, and wouldn’t even eliminate the sizable chunk of Greek debt that is denominated in foreign currency. In short, it remains a last resort or last resorts, and isn’t even on the table at the moment.

If investors learned anything from the credit/housing crisis, it is that things can quickly go from bad to worse, and they don’t want to have to learn that lesson a second time with Greece and the Euro. In the end, investors will stay away until there is more clarity surrounding Greece’s finances. Until then, betting on the Euro would be an “aggressive call.”

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Swiss Franc Surges to Record High: Where was the SNB?

Mar. 26th 2010
One of the clear victors of the Greek sovereign debt crisis has been the Swiss Franc, which has risen 5% against the Euro over the last quarter en route to a record high. 5% may not sound like much until you consider that the Franc had hovered around the €1.50 for most of 2009. Every time it budged from that mark, the Swiss National Bank (SNB) moved swiftly to return the Franc to its “resting spot.” So where was the SNB this time around?
Swiss Franc Euro chart
Beginning last March, the SNB was an active player in forex markets: “Quarterly figures indicate the central bank spent some 4 billion euros worth of francs in March, 12 billion in the second quarter, some 700 million euros in the third quarter, and some 4 billion in the fourth.” In fact, the SNB might still be intervening, and it won’t be until 2010 Q1 data is released that we will be able to say for sure. The Franc’s rise has certainly been steep, but who’s to stay that it couldn’t have been even steeper. For comparative purposes, consider that the US Dollar has risen more than 10% against the Euro over this same time period.
But the fact remains that the “line in the sand” was broken and the Swiss Franc touched an all-time high of €1.43. According to SNB Chairman Philipp Hildebrand, “We have a broad range of means to prevent an excessive appreciation and we are going to do this to ensure that the recovery can continue. The instruments are clear: We buy foreign currencies. We can do that in very large quantities.” In other words, he is sticking to the official line, that the SNB forex policy has not yet been abandoned. On the other hand, “SNB directorate member Jean-Pierre Danthine said Swiss companies and households should prepare for a market-driven exchange rate some time in the future.”
Actually, I don’t think these two statements are necessarily contradictory. The Franc is rising against the Euro for reasons that have less to do with the Franc and more to do with the Euro. At this point, if the SNB continued to stick to its line in the sand, it would look almost illogical, especially since by some measures, the Swiss Franc is already the world’s most manipulated currency. Besides, by all accounts, the interventionist policy has been a smashing success. The forex markets were cowed into submission for almost a year, which prevented the Swiss economy from contracting more and probably paved the way for recovery. 2009 GDP growth is estimated at -1.5% with 2010 growth projected at 1.5%.
By its own admission, the SNB did not target currency intervention as an end in itself. “If you want to assess the success, then you should not only look at a certain exchange rate, but look at the success of the Swiss economy.” Rather, its goal was monetary in nature. Since, it cut rates to nil very early on, the only other way it could tighten is by holding down the value of the Franc. Along these lines, the SNB will continue to use the Franc as a proxy for conducting monetary policy: “An excessive appreciation is if deflation risks were to materialise. We will not allow this to happen.”
Going forward then, it seems the Franc will continue to appreciate. “I think the marketwill cautiously continue to sell the euro against the Swiss franc and perhaps see whether the SNB will step in and try and stop the Swiss franc strength,” said one analyst. As long as the Swiss economy continues to expand and deflation remains at bay, there is little reason for the SNB to continue. Besides, intervention is not cheap, as the SNB’s forex reserves grew by more than 100% in 2009. On the other hand, the SNB has probably intervened in forex markets on 100 separate occasions over the last two decades, which means that it won’t be shy about stepping back in if need be.
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Posted by Adam Kritzer | in Central Banks, Euro, News, Swiss Franc | 2 Comments »

A Break-Up of the Euro?

Mar. 24th 2010
Lest you accuse me of doomsday predictions and excessive fear-mongering, consider that I have only broached this topic on one previous occasion. In 2005, it was suggested that the Euro would dissolve since a handful of member countries (France and the Netherlands) rejected the new EU Treaty. [Alas, the tragedy was averted when both countries’ Parliaments ratified the Treaty against the wishes of their respective electorates]. This time around, however, the problems are deeper, and are economic rather than political.
Last week [EU Debt Crisis: Perception is Reality], I wrote that Greece only has three possible choices in dealing with its fiscal problems: clean up its finances, pray for a bailout, or (partially) default on its debt. Here I overlooked a fourth possibility: leaving the Euro and devaluing its debt. That this was originally omitted was not an oversight, but proof that this is considered a last resort of last resorts. Most analysts believe that Greece would sooner default on its debt than leave the Euro.
euro dollar 1 year chart march 2010
I’m inclined to agree. The Greek economy benefited from inclusion in the Euro zone in the form of lower interest rates and increased credibility. Sure, it took advantage of these perks by running up record budget deficits, but one can hardly blame the Euro since Greece binged voluntarily. The responsible move might be for the EU to kick Greece out, akin to the bartender cutting off the alcoholic; you wouldn’t expect the alcoholic to voluntarily stop drinking.
For now, Greece is saying and doing all of the right things to placate both EU officials and its own lenders. On the other hand, it faces increasing pressure from its populace. Fiscal austerity during an economic recession is a recipe for political disaster: “Greek workers disrupted transportation services and tried to storm parliament on March 5 as lawmakers passed 4.8 billion euros ($6.6 billion) of extra deficit reductions, including lower wages for public employees. Such cutbacks will continue to run into resistance as unemployment is propelled above December’s 10.2 percent.” Since both of these extremes (fiscal crisis on the one hand and civil unrest on the other) are equally untenable, some analysts think the only solution will be for Greece to leave the Euro.
Given that Greece’s economy only accounts for 2% of EU GDP, it won’t make too many waves regardless of what happens. The bigger problem, looming on the horizon, is Spain. Spain accounts for close to 15% of EU GDP, and the economic slowdown hit the nation hard. Low interest rates fomented a massive property and infrastructure boom, and the subsequent easing of monetary policy (to soften the collapse), succeeded only in stoking inflation. The concerns are twofold: that the economic crisis can’t resolve itself without deflation, and/or that economic crisis will trigger a fiscal crisis. While Spain is still far from fiscal crisis, it’s worth pointing out that fiscal austerity will be difficult (because of the economic downturn) and that an EU bailout would impossible because of its size.
The situations in Spain and Greece (Ireland and Portugal could also be included) have underscored concerns harbored by many economists since the creation of the Euro. They argue, namely, that the common currency has allowed poor countries to borrow more than they otherwise would have been able to, and that the common monetary policy has resulted in harmful gaps between countries in inflation and economic growth. “They have a single monetary policy and yet every country can set its own fiscal and tax policy. There’s too much incentive for countries to run up big deficits as there’s no feedback until a crisis,” summarized Harvard economist Martin Feldstein.
Feldstein and a chorus of others are now openly predicting the breakup of the Euro. Former U.K. Treasury adviser Roger Bootlehas asserted that, “As countries in the euro area are ‘forced to cut back on fiscal deficits, they’re going to face many years of depression and deflation. It’s doubtful politically they can hold that line.” Naturally, most still dismiss this as an outside possibility, with ECB President Jean-Claude Trichet going so far as to call it “absurd.”
Given that the crisis countries (Greece, Spain, etc.) will probably fight the hardest for the Euro’s preservation, Trichet is probably right. “Support for monetary union was highest in Spain, ‘much higher than in Germany, where a lot of people were reluctant because they already had a strong currency…So Spain is very pro-European.’ As a result, the chances of Spain pulling out of the euro are ‘just unthinkable.’ ” Still, even the outside possibility is enough to make investors nervous.
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EU Debt Crisis: Perception is Reality

Mar. 18th 2010

I wonder if I wasn’t a little glib in my last post (Dollar Returns to Favor as World’s Reserve Currency)when I implied that the Euro would necessarily continue falling because of ongoing sovereign risk crises. In actuality, the situation is much more nuanced, and I want to qualify this idea below.

As I’ve said before, the sudden sovereign debt crisis in Greece is one of many. While its fiscal problems are certainly serious, they are not markedly worse than those of other countries, and it’s somewhat hard to understand why the markets suddenly decided to gang up on Greece. As many analysts have been quick to point out, Portugal, Ireland and Spain are in equally bad shape. Perhaps, it is the unique combination of factors which has led investors to focus on Greece in particular: “Greece stands out for the size of its debt stock, the scale of its budget deficit and the grimness of its growth prospects given high domestic costs and an inability to devalue.” But again, this inability to devalue its debt is shared by every other member of the EU. By virtue of belonging to the Euro, all of these countries must face their debt problems as they are, and cannot attempt to alleviate them through currency depreciation.

It is for this reason that I think that the EU will continue to be the main loser from real (and perceived) debt crises. As you can see from the table below, of the ten countries whose debt positions are least sustainable, seven of them are current members of the EU. This is problematic for the Euro, because as far as currency markets are concerned, one country’s problem is automatically a pan-EU problem.


 If you look again at the Greek debt crisis specifically, there are really only three possible outcomes: “one of the most excruciating fiscal squeezes in modern European history – reducing the deficit from 13 per cent to 3 per cent of gross domestic product within just three years; outright default on all or part of the Greek government’s debt; or (most likely, as signalled by German officials on Wednesday) some kind of bail-out led by Berlin.” While such a bailout would temporarily stabilize the crisis, it would set a dangerous precedent in terms of dealing with fiscal crises in other EU countries and would do nothing to solve Greece’s underlying structural problems. Only under the first outcome, then, would the Euro not suffer, and unfortunately this one seems least likely.

Of course, the ultimate resolution of the crisis is still many years away. For now, currency traders are perhaps less interested in whether Greece will get its fiscal house in order and/or receive an EU bailout, and more concerned with how perceptions of the crisis will evolve. Recently, many investors have been taking their cues from the market for credit default swaps (CDS), which functions as insurance against and can be used to gauge the likelihood of sovereign default. In the case of Greece, CDS premiums have been rising (now implying a 4%+ chance of default), even though demand for Greek bond issuances remain strong at moderate interest rates. This discrepancy can best be explained by the presence of speculators, which are also working to push the Euro down.

Interestingly, the EU is currently mulling a ban on speculative (naked) CDS purchases, which would theoretically lead to lower CDS premiums and in turn, assuage other investors that the likelihood of a Greek default is low. On the face of things, this would probably – investment and lending in the EU, as sovereign risk would be less of an issue. However, there is still the possibility that speculators would continue to push down the Euro, for lack of a better strategy. In fact, they could even redouble their short bets against the Euro, since the CDS ban would deprive them of a valuable strategy for betting directly against Greece. (In fact, CDS speculation, while leading to higher interest rates and making it more difficult for Greece to finance its deficit, actually has no direct effect on the Euro, since it doesn’t necessitate a cross-border transaction).

Alas, then, it’s actually hard to predict (as always!) the near-term direction of the Euro. Since the crisis is still more perceived than actual, it’s clear that the Euro decline is a product of speculation and uncertainty, neither of which will disappear anytime soon. The best hope, then, for the Euro is probably just that investors will simply get bored with the story – as they eventually always do – and turn their attention to something else.


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Speculators Pile Up Against Euro

Mar. 1st 2010

The Wall Street Journal’s coverage of the Greek dent crisis has focused less on the crisis itself, and more on the markets’ reaction to it. With headlines like “Hedge Funds Try ‘Career Trade’ Against Euro” and “Speculators Bet Record Amount Against Euro For 4th Week” and “Europe Trouble, U.S. Opportunity” – among others – the WSJ has identified a collapse in the Euro (mainly against the Dollar) as one of the most prominent (and profitable!) strategies for exploiting the crisis.

As I mentioned in the last post (“Understanding the Greece Situation“), the debt crisis has become self-fulfilling, not only for Greece, but also for the Euro. In other words, as perceptions abound that Greece is insolvent and the Euro is doomed, Greek bonds and the Euro have lost value, which only makes the crisis worse. It seems that speculators are taking advantage of this phenomenon by making large bets against the Euro. In fact, large is an understatement, as the net short positions against the Euro now total a record $12 Billion, according to the closely watched Commitment of Traders report.

Some analysts have taken such information at face value, noting that “The fact that the shorts got even shorter when they were already at extreme levels highlights just how negative the sentiment is toward euro.” On the other hand, there is evidence (and some degree of admission) that large speculators are now acting in concert to bring down the value of the Euro. The WSJ reports mention private meeting between hedge funds managers and investment banks helping their clients bet against the Euro using derivatives. For those that are skeptical that speculators could really influence currency markets, consider that one man – George Soros – single-handedly forced a devaluation of the Pound in 1992, and made $1 Billion in the process. While the Euro is certainly bigger than the Pound ever was, there are more people watching it than ever, and when there is money to be made –  hundreds of billions of dollars in this case – it isn’t inconceivable that the Euro could suffer a similar fate.

Already, there is evidence that this strategy is working, as the Euro has fallen 10% in less than three months, which is unbelievable for a currency whose daily trading volume is estimated at $1.2 Trillion. In fact, one popular options trade is based on the the Euro falling to parity against the Dollar. Once unthinkable, such a possibility now faces odds of “only” 1 in 14 (based on options premiums), compared to 1 in 33 in November. On the one hand, it’s frustrating to accept the market power that these speculators have. But emotion has no place in (forex) trading, and standing in the way of momentum would be costly.

On the other hand, Euro fundamentals remain strong. To be sure, a currency is only as strong as its constituent parts, and the fact that a handful of EU member states have shaky finances certainly cannot be dismissed. At the same time, the fact that such currencies have no direct control over the Euro is just as important. Before the inception of the Euro, currency traders would be justifiably concerned that a country in a similar position to Greece would deliberately devalue its currency (by printing money) in order to devalue its debt and make it more manageable.

Now, this would be impossible, since the Euro is controlled by the European Central Bank, over which Greece has no power. The current crisis in Greece notwithstanding, “The European Central Bank’s (ECB) resolve to maintain sound money is…important. This is especially true for the ECB, which has a single mandate—price stability—unrelated to fiscal problems.” While there is legitimate concern that the ECB will be forced (or voluntarily) print more money to fund bailouts of bankrupt EU member states, this doesn’t seem very likely, given the history of the ECB. Its monetary policy has always been quite conservative, and it’s no wonder that the Euro has come to be seen as a viable alternative to the Dollar.

In my opinion, the decline in the Euro is mostly baseless, and if it were to continue, it wouldn’t represent the prevailing of logic. Then again, logic is not exactly a word that I would apply to the forex markets, now or ever.

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Understanding the Greece Situation

Feb. 26th 2010

With this post, I want to try to clarify the Greek fiscal crisis. The problem is that it’s not clear exactly how serious the problem is, because most of the media coverage of the crisis has been directed towards the financial markets’ perception of it, rather than its underlying fundamentals. In the end, I think it’s important to understand both.

The Financial Times published a great timeline that shows perception and reality side-by-side. While there were certainly other important developments that bear in Greece’s fiscal position (in addition to those listed below), you can see that financial markets are basically making their own reality. For example, there was hardly a response to the October announcement that Greece’s budget deficit would be 12.7%, which was 5% higher than earlier estimates. In fact, the markets only became bearish on Greek debt after it the government announced that it would try to bring the debt down to 9.4% through various measures.

Greece debt timeline
Apologists for the markets would be right to wonder why investors should be inclined to believe the government of Greece when it said it could control the budget deficit. Fair enough. Still, one has to wonder why the markets suddenly started worrying about Greece’s fiscal problems, when only a couple months ago, the possibility of a whopping 12.7% budget deficit barely caused investors to blink. Besides, the credit crisis has been raging since 2008, which means the markets have had plenty of time to digest the implications of recession for Greece’s fiscal position.

These days, where is a financial crisis, chances are derivatives are not far removed. As credit default swap spreads (i.e. the cost of insuring against default by Greece on its loan obligations) have risen, so have concerns that this is a bona fide crisis. “It’s like the tail wagging the dog…There is a knock-on effect, as underlying positions begin to seem riskier, triggering risk models and forcing portfolio managers to sell Greek bonds,” said one portfolio manager. From this perspective, it almost looks like this “crisis” is being completely manufactured by speculators for the sake of profit. Summarized another analyst, “It’s like buying fire insurance on your neighbor’s house — you create an incentive to burn down the house.”

Greece credit default swap spreads
To be fair, Greece also played a role in derivatives speculation, and on some level, it was even more nefarious than the speculators. Assisted by Goldman Sachs (who is now betting on Greek default [how un-ironic that is!]), Greece entered into a series of swap agreements last decade, which it used to conceal its true debt burden. “By using an historical exchange rate that didn’t accurately denote the market value of the euro, Goldman effectively advanced Greece a €2.8 billion loan. Under EU accounting rules—which were tightened in 2008—Greece wasn’t obliged to include the loan in overall public debt on its books.” Now that those transactions have been uncovered and the truth is coming to light, financial markets are rightly re-evaluating the risk of further lending to Greece.

There is no question that Greece’s debt problems are serious. As to whether labeling it a crisis is necessary, that depends on your standards. Greece ranks near the top of the list on a variety of individual “debt sustainability” criteria. At 94.6% of GDP, it’s net debt is among the highest in the world. Its projected 2010 budget deficit is also high, though not the highest. Its cost of borrowing is also significantly higher than projected GDP growth, which means that net debt will continue to grow until a budget surplus can be produced. When you average these measures together, it appears that Greece’s debt problems are the most unsustainable of any country in the world. But this is hardly news.

Debt Sustainability
On the other hand, the weighted average of the maturity of Greek debt is 7.7 years, well above average, and plenty of time (relatively) for Greek to sort through this mess and secure new lenders. Towards the latter end, it has hired a former bond trader to head its debt management agency. In order to improve its fiscal position, it has announced a series of austerity measures, including budget cuts, tax increases, wage cuts for public-sector employees, and stricter laws against tax evasion.

At this point, a ratings downgrade looks inevitable, and some analysts think the crisis has already become self-fulfilling. As borrowing costs rise, it only makes it more likely that Greek will default, which causes rates to rise further, and so on. On the other hand, Greek politicians are being forthright about their position (“Greece’s finance minister, George Papaconstantinou, remarked this week: ‘People think we are in a terrible mess. And we are.’ “) and have a plan for rectifying the situation. There is cause for skepticism here, but also for hope. And that goes not just for Greece, but also for the Euro.

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Pound’s Fate Tied to EU Debt Crisis

Feb. 17th 2010

Since the emergence of the debt crisis in Greece, UK policymakers have been once again patting themselves on the back for not joining the Euro. Otherwise, they would currently be in the same awkward position as France and Germany, whose economic might underpins the entire Eurozone and are wondering about if and how they should lend their support to Greece. Given that the Pound has fallen at an even faster clip than the Euro in recent weeks, however, it seems investors don’t share their sense of complacency. What gives?

One might be inclined to posit that the Pound is falling for reasons unrelated to Greece and the travails of the EU. After all, most of the economic data emanating from the UK these days isn’t exactly positive. GDP grew by an abysmal .4% in the fourth quarter of 2009, and the Bank of England, itself, has revised is 2010 projections down to 1.5%. In addition, inflation is creeping up and short-term rates remain low, such that real interest rates (and by extension, the carry associated with holding Pounds) in the UK are effectively negative.

While this alone would be grounds for selling the Pound, a cursory glance at GBP/USD and EUR/USD cross rates reveals that the Pound and Euro are falling in tandem. In my eyes, this implies that investors have impugned a connection between the situation in the EU (i.e. Greece and the other “PIGS” economies) and in the UK. And no wonder, since UK debt levels are as worrisome as any other country, developing or industrialized. Its budget deficit is 13%, slightly higher than in Greece. Private debt is estimated at £1.5 Trillion, or £60,000 per household, which is the highest (in relative terms) in the world. “Then there’s the trillion-pound bank bail-out, the trillion-pound public-sector pension liability, the trillion-pound public debt and those off-balance-sheet private finance initiatives schemes. If you add up Britain’s real liabilities you find that the UK is heading for a total debt burden of several times its GDP,” summarized one analyst.


Of course, this is nothing new. I, myself, have written about the looming UK debt crisis on previous occasions. While such a crisis is still years away, the turmoil in Greece is causing investors to cast fresh eyes on the similarities and differences with the UK, and they clearly don’t like what they see. On the one hand, Britain’s monetary independence means that it can deflate its debt (by simply printing more money), unlike Greece, whose membership in the European Monetary Union precludes such a possibility. While this means that Britain is ultimately less likely to default on its debt, it makes it more likely that it its currency will have to weaken at some point in the future, so that its liabilities remain manageable. Bond investors, then, are right to prefer UK Bonds, but currency investors are equally right to shun the Pound in favor of the Euro.

It seems that Britain’s conception of itself is somewhat flawed. While it thinks of itself as akin to France or Germany (and hence, is quite happy not to be an EU member at the moment), the markets seem to think of it as a Spain or Portugal. The implication is that the markets currently believe that the UK would do better if it was a member of the EU than on its own. Of course, that proposition is debatable (and still unlikely), but it’s worth bearing in mind because it’s what investors apparently believe.

As usual, the BOE remains (perhaps willfully) oblivious of all of this. It is mulling an extension of its quantitative easing program, which is supposed to end this month. This program is responsible for an expansion of the money supply equal to 14% of GDP in 2009 alone! Most economists consider it a dismal failure, and it seems to have succeeded only in catalyzing growth in prices (aka inflation) rather than output (aka GDP). “The suspicion is that the UK government and Bank of England is not worried that the pound remains weak in this repositioning of currencies. They may indeed welcome it. There is no immediate appetite for raising interest rates to strengthen sterling and no point making exports harder by strengthening the exchange rate.” They would be wise to bear in mind, though, that while currency depreciation is useful for devaluing existing debt, it can have the unintended consequence of scaring off investors, and make it difficult to fund future debt.

Currency investors may be ahead of them on this one.

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Could Greece’s Fiscal Problems Really Sink the Euro?

Feb. 12th 2010

Currency markets operate in funny ways. Greece’s fiscal problems are hardly a new development. During years of boom and bust alike, it ran unsustainable budget deficits. Why investors have decided to fret now – as opposed to last year or next year, for example – on the distant possibility of default, is somewhat mysterious.

After all, the credit crisis exploded in 2008, and conditions now are inarguably more stable than they were at this time last year, when volatility and credit default spreads (insurance against bond default) – two of the best measures of investor risk sensitivity – were still hovering around record highs. On the other hand, the unveiling of Dubai’s hidden debt problems, has certainly provided impetus to investors to re-evaluate the fiscal situations in other highly leveraged economies. In addition, Greece just estimated that its budget deficit for 2010 at 12.7%, 4% higher than earlier estimates, which were also shockingly high. Regardless of 1, the markets are now focused firmly on Greece – and by extension, the Euro.

How serious are Greece’s fiscal problems? Serious, but not insurmountable. Its sovereign debt recently surpassed 125% of GDP, higher than the US, but lower than Japan, for the sake of comparison. Of course, the Greek economy is hardly a picture of robustness. Neither is the US, these days, for that matter, but its size means that it is pretty much immune from speculative attacks on its credit and capital markets. Greece, on the other hand, remains extremely vulnerable to the whims of international investors.

On the whole, these investors still remain willing to finance Greece’s budget deficits; the last bond issue was five times oversubscribed, which means that demand exceeded supply by a healthy margin. Still, interest rates are rising quickly, and spreads on credit default spreads have risen above 400 basis points, suggesting that nervousness is growing and Greece cannot take for granted that future bond issues will be met with such healthy demand.

In this context, in stepped the European Union. In fact, it isn’t even clear if Greece asked for help. As I pointed out above, the Greek debt “crisis” is largely playing out in capital markets, and doesn’t necessarily reflect a change in the fiscal reality of Greece. Still, leaders of the EU were alarmed enough to convene a meeting between the finance ministers of member states, to discuss their options.

After weeks of denial that any kind of aid to Greece was being considered, EU political leaders announced that they were prepared to step in to help after all, but they were vague on the details. There were no ledges of specifc dollar amounts, only hazy promises of support should conditions warrant it. In the end, what was clearly intended to comfort the markets achieved the opposite effect, as investors took no comfort in the “moral support” and worried about the new uncertainty.

It’s premature to say whether this whole episode will threaten the viability of the Euro. Much depends on whether Greece (Portugal and Spain, too, for that matter) can get its fiscal house in order (Among other things, it has promised to reduce its 2010 budget deficit by 4%). More importantly, it depends how, and to what extent, the EU responds to this crisis as a community. The Euro is already 10 years old, and you would think that it would have been accepted already within the EU, as it has by the rest of the world. On the contrary, it remains deeply divisive and fraught with politics. Many of its critics have seized on this opportunity to challenge to raise fresh calls for its abolishment. If the problems of Greece deteriorate to the point that other EU members are actually required to intervene, you can expect these calls to crescendo.

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SNB: Intervention Back on the Table

Jan. 26th 2010

Pull up a 1-year chart of the Euro against the Swiss Franc, and you’ll quickly notice a salient trend: the exchange rate has hovered slightly above €1.50 since last March, with three notable deviations. The first occurred last March, when the Swiss National Bank (SNB) intervened in currency markets on behalf of the Swiss Franc, causing the Franc to shoot up instantly by more than 5%. The second took place in June, when the SNB threatened (it may or may not have actually intervened) intervention again, and the Franc shot up in order to create a buffer zone. The final deviation can be seen at the end of December, when a generalized decline of the Euro also manifested itself against the Swiss Franc, as it fell significantly below the €1.50 threshold.

Euro - Swiss Franc 2009 -2010
It’s not clear whether €1.50 was ever conveyed by the Swiss National Bank explicitly, or whether it was merely accepted implicitly by the forex markets. Regardless, traders certainly respected this boundary, and for most of 2009, dared not challenge it. At the end of December, as I said, there were two important developments, which bore on the EUR/CHF cross. First, credit downgrades and the (far-off) prospect of sovereign default in the EU set loose a wave of panic, after which the Euro has generally fallen. The second development was a subtle change in the wording of the SNB’s forex policy. Previously, it had promised to prevent any “appreciation” in the Swiss Franc, whereas now it is only interested in stopping an “excessive” appreciation.

It’s not clear whether the Swiss Franc suddenly blasted through the €1.50 because investors believe(d) it was undervalued, or if instead it merely got caught up in the Euro’s weakness. Perhaps, investors realized that now they had an excuse to sell the Euro and no longer had to worry about whether actually doing so would risk provoking the SNB. It was probably a combination of both.

For its part, the SNB (through its President and chief mouthpiece Philipp Hildebrand) is already sending subtle clues to the forex markets about the Franc’s prospects. Hildebrand recently told reporters both that “Raising interest rates would be inappropriate,” and “Since the recovery is still fragile, the current expansionary monetary stance will need to be maintained until the recovery strengthens and deflationary pressures recede.” In other words, those that bet on Franc’s appreciation shouldn’t expect any return on their investment, in the form of higher interest rates.

He also reiterated the SNB’s stance on the Franc more explicitly: “Our policy is clear: we will resolutely prevent an excessive appreciation as long as there are deflationary risks.” Given that the markets called his bluff in December, investors are unfazed: “The difference in the number of wagers by hedge funds and other large speculators on an advance in the franc compared with those on a drop, so-called net longs, was 13,926 on Jan. 12 compared with net shorts of 2,780 a week earlier.”

In all likelihood, the Franc will continue to hover around €1.50, only below that barrier, rather than above it. As long as the Franc remains basically stable, either in literally not moving, or in appreciating at a snail’s pace, the SNB probably won’t get involved. After all, the change in wording to its forex policy is a tacit admission that €1.50 is arbitrary and that perhaps the Franc could stand to gain a little bit, especially in the context of the EU fiscal issues. Not to mention that intervention is expensive and ineffective in the long-term.

If traders really get ahead of themselves, though, Hildebrand has already proven that he’s not afraid to act.
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Forex Reserves in Transition: Is the Euro Making a Run?

Jan. 17th 2010

With so much to think about these days, I havn’t spent much time poring over foreign exchange reserve statistics. Apparently, this is to my detriment, as there have been a number of important developments on this front, some of which carry far-reaching forex implications.

I’m guessing a lot of you are probably in the same boat as me, wondering why forex reserves are worth paying any attention to. While busy looking at complex charts and GDP/inflation statistics, however, we forget that a currency’s value is fundamentally determined by supply and demand. In other words, while bullish/bearish indicators and interest rates are the proximal factors behind forex, the supply/demand dynamic is the ultimate factor. And Central Banks, collectively, comprise one of the largest contingents behind this supply/demand.

As I was saying, this equilibrium is currently undergoing a seismic shift. Specifically, “The dollar’s share in official foreign exchange reserves in 140 countries has fallen to its lowest level since euro cash was introduced in 2002, according to the IMF.” The Euro, Yen, and “other currencies” (i.e. minor currencies that are collectively important but individually unimportant), meanwhile, have seen increased interest from Central Banks. This is consistent with another report I saw recently, enunciating that,”Global reserves probably gained by about $180 billion in the third quarter with U.S. dollar-denominated reserves accounting for about $50 billion or less than 30 percent.”

This came as a shock to many market observers, who assumed that many economies lacked either the capacity or the impetus to diversify their reserves, especially since many of them peg their currencies to the Dollar. These countries are savvier than they used to be, however: “Emerging market central banks are selling their local currencies and buying U.S. dollars to prevent appreciation of their currencies. They’re avoiding having a bigger concentration of U.S. dollars in their portfolio by turning around and selling dollars against the euro and other currencies.”

Even industrialized countries, whose forex reserves are dwarfed by their emerging market counterparts, are jumping into diversification. After a nearly 10-year hiatus, Canada will jump back into the forex reserve game, by $1 Billion in foreign currency bonds, denominated in Euros. According to one analyst, “This…should be viewed in the context of the entire developed world, which is in the process of generally ramping up the size of its foreign reserves, and subtly shifting away from USD.”

The wild card is China. I use the term wild card both because China’s forex reserves are the world’s largest (recently confirmed at $2.4 Trillion) and hence whatever it decides will have major implications, and because it does not report the specific composition of its reserves to the IMF, so it’s unclear how it’s outlook is changing from month to month. Plus, it offers only vague indications of its intentions, so all we can do is speculate.

But speculate we will! While China has publicly maintained its support for the Dollar, quasi-publicly, there is an abundance of concern. This has most recently manifested itself in the form of internal calls for China to use its hoard of reserves to buy natural resources abroad. This wouldn’t necessary involve large-scale selling of its Dollar-denominated assets – since most oil contracts, for example, are still settled in Dollars – but would certainly involve shedding some of them.

As for why Central Banks are dumping Dollars (or simply choosing not to accumulate more of them), that seems pretty obvious. Even ignoring the Dollar’s problems, a well-balanced portfolio is an exercise in risk management. Especially now that many of the Dollar’s rivals are as liquid and as stable as the Greenback, itself, it makes little sense to put all one’s eggs in one basket.

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Euro: It’s Still Mostly About the Dollar

Dec. 5th 2009

It’s been a while since I last wrote about the Euro (October 26: Euro Optimism (And not just Dollar Pessimism)). That’s because my perspective recently has been mainly Dollar-centric; I continue to believe that much of the recent movement in forex markets (with the exception of certain cross rates) can best be explained by the Dollar. Nowhere is this more evident than the Euro, whose rise should really be thought of in terms of the depreciation of the Dollar. It’s no surprise then that yesterday’s Euro decline – the steepest in months – was the result not of internal European developments, but rather of the US jobs report.

eurp dollar
One analyst summarized the Euro’s ascent by noting, “The bias for risk-seeking is still in vogue.” This has nothing to do with the Euro, but rather is a roundabout way of speaking about the Dollar carry trade, which is responsible for an exodus of capital from the US, some of have which has no doubt found its way into Europe. In some ways, then, it’s almost pointless to scrutinize EU economic indicators too closely.

That being said, there are a few meaningful observations that can be made. The first is that the EU economy is tentatively in recovery mode. Some of the most closely-watched indicators such as the German IFO index, capacity utilization, and Economic Sentiment Indicator, have all ticked up in the last month, while the unemployment rate is holding steady. For better or worse, this improvement can attributed entirely to export growth, due to the recovery in world trade. GDP rose by .4% in the most recent quarter, which means that the Euro Zone has officially exited the recession.

The second observation is that many expect this exit to be short-lived. Due to the relative rigidity of the EU economy, specifically regarding the labor market, it may take additional time to get back on really solid footing. Thus, the European Commission “thinks that euro-area unemployment will continue to rise next year, reaching 10.9% in 2011. That will dampen consumer spending. Another worry is investment, which the commission thinks will fall by 17.9% this year. Businesses are unlikely to waste scarce cash on new equipment and offices when they have spare capacity. Firms confident enough to splash out may find it hard to secure the necessary financing from fragile and risk-averse banks.” The Commission also expects public finances to continue to deteriorate, perhaps bottoming at some point next year. There is even an outside concern that one of the fringe members of the EU could default on its debt, requiring a bailout in the same vein as the lifeline grudgingly being thrown to Dubai by the UAE.

Finally, there is the European Central Bank. Much like the Fed – and every other Central Bank in the industrialized world, except for Australia – the ECB is nowhere near ready to hike rates. “The overall economic context doesn’t suggest that they would want to tighten anytime soon. There is a feeling that, yes, things have improved, but that nonetheless, the outlook is still quite fragile,” summarized one economist. Sure, the ECB is winding down its liquidity programs, but so is the Fed. Based on long-term bond yields, investors believe that US rates could even eclipse EU rates at some point in the future.

In short, there isn’t really much to be optimistic about, when it comes to the Euro. The nascent recovery is hardly remarkable, and probably not even sustainable. While the Euro might continue to perform the Euro in the short-term for technical reasons, I would expect this edge to evaporate in the medium-term.

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Euro Optimism (And not just Dollar Pessimism)

Oct. 26th 2009

According to a recent Merril Lynch (Bank of America) survey, Europe has officially returned to favor among investors. “A net 30% of global portfolio managers see euro-zone equities as undervalued relative to other regions, the highest reading since April 2001. A net 11% are overweight Europe, the first overweight allocation in nearly two years, said Baker.”

The numbers, meanwhile, reflect this perception. Over the last month, investors have poured a net (inflows minus outflows) $2.1 Billion into EU capital markets, an impressive sum when you consider that the figures for Japan and the US were both negative. Meanwhile, stock markets in the region are up by 50%+ since bottoming last March. When you account for currency fluctuations (i.e. Euro appreciation), stock market comparisons between the US and EU start to look pretty lopsided.

According to a WSJ report, there’s no mystery behind the European stock market rally: “Even though prices have risen sharply since March, valuations aren’t stretched. Average price-to-earnings ratios in Europe, on a trailing 12-month basis, are about 16, up from seven back in March, according to Citigroup…On a price-to-book ratio, stocks are trading about 15% below their long-term average, and dividend yields compared to government bond yields are historically still very attractive.”

EU stocks

At this point, you’re probably wondering, “Why the long preamble on European stocks?” Because, it’s easy to forget that there are inherently two sides to every currency pair. In the case of the USD/EUR (the most frequently traded pair in the world), most of the recent commentary has focused exclusively on Dollar-negatives, portraying the dynamic as a depreciation in the Dollar. In this context, it’s easy to forget that the Dollar’s depreciation implies an appreciation in the Euro. Duh?! But seriously, for every Dollar bear, it seems there is at least one Euro bull.

To be fair, those who don’t see much to be excited about in the Euro can be forgiven. After all, the European economy is technically still mired in recession, and isn’t projected to return to growth until 2011. While some of the intangible indicators are improving, others continue to stagnate. “Industrial output in the euro zone is 20% lower than its February 2008 peak, despite some recent improvements.” In addition, the appreciation in the Euro threatens to choke off exports and stifle the recovery before it has a chance to get off the ground.

Speaking of which, the European Central Bank (ECB) will probably hold of on raising rates because of the strong currency. A more valuable Euro keeps inflation in check (via cheap imports). Besides, higher interest rates would attract carry traders hungry for yield, and would make it even more difficult to keep the Euro in check. Many EU monetary officials (including ECB President Jean-Claude Trichet) have already made their concerns about the Euro’s appreciation clear. If they are able to succed in halting its rise, that could make investing in Europe a lot less exciting…


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Posted by Adam Kritzer | in Euro, News | 5 Comments »

Euro retreats from 2009 Highs

Aug. 18th 2009

In forex, timing is everything. If I had written this post a couple weeks ago, the headline would read “Euro Touches 2009 High.” Perhaps if I had waited another week, it would have read, “Euro Approaching 2009 High.” But alas, I chose today to write about the Euro, and the headline I chose is probably the most appropriate under the circumstances.

On August 5, “The euro hit a high for the year against the dollar as stocks trimmed their losses in afternoon trading Wednesday despite a generally cautious tone in currency markets.” Analysts were careful to point out that the markets remained cautious and the Euro eased past – rather than smashed through – its previous high. Technical analysts would and have argued that this paved the way for the subsequently rapid decline: “The euro is testing the base of an ascending channel with daily momentum charts showing a ‘double top in overbought territory.’ ”

This notion might have some merit, considering that fundamentals arguably favor a continued Euro appreciation. “The economy of the 27-country European Union shrank 0.3 percent in the three months ended June 30, for an annual rate of roughly 1.2 percent. The 16 countries that use the euro registered a 0.1 percent decline for the second quarter, or an annual rate of roughly 0.4 percent.” While output remains well below its 2008 levels, the slight contraction represents a tremendous improvement from the first quarter, when GDP shrank by 2.5%.

“Underlying the strong reading were solid performances in France and Germany, each of which grew 0.3 percent in the second quarter, government data showed.” This is helping to offset further contractions in Italy and Spain, which have turned into economic laggards as a result of the housing bust. In addition, exports in Germany grew by 7% last month, and “Investor sentiment improved more than analysts had expected in August to its best level since April 2006.” On an aggregate basis, “the euro zone’s trade balance with the rest of the world rose to 4.6 billion euros ($6.5 billion) in June, compared to a flat balance in the same month last year,”

Still, explorers looking for bad news and/or cracks beneath the surface will have no difficulty finding them. German exports (and output in general remain down year-over-year. In addition, there are still trouble spots in the EU, notably in western Europe. “Already, the euro area’s unemployment rate stands at 9.4 percent, its highest level in 10 years, and the anemic growth of the coming quarters will not be enough to arrest the slide. That, in turn, could drag down consumer confidence or even generate political backlash in Europe, economists said.” Most worrying is perhaps that, “consumer prices in the euro area dropped 0.6 percent in July…” ‘Deflation is becoming entrenched in the euro area, which would be very bad for the economy.’ ” Good thing the ECB left some room to lower rates further.

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ECB to Hold Rates Until 2011

Jul. 23rd 2009

The next rate-setting meeting of the European Central Bank (“ECB”) is rapidly approaching (August 3), and analysts are stepping up to offer their opinions on the direction of EU monetary policy. At its last meeting, on July 2, the ECB voted to hold rates at the current record-low level of 1%, and all indications are that the August meeting will yield the same result.

Despite getting off to a late start, the ECB has since moved adroitly to strike a balance in its monetary policy between inflation and growth. For those that insist that its rates are still too high – especially compared to the US and UK – the ECB can counter by arguing that this way it still has some scope to lower rates, if need be. “If a deflationary spiral does become entrenched, unlike most of the other major global economies, at least the European Central Bank still has some of the interest rate tool left to fall back on,” agrees one analyst.

The ECB can also refer critics to its overnight lending rate, which are 75 basis points lower than its main policy rate. “Before the crisis, the ECB would aim to keep overnight interest rates close to the refi rate. Since it moved to unlimited fixed-rate funding, the central bank has been content to allow the overnight rate to drift much lower than the policy rate.” It is at this refinancing rate that it recently lent out a record €442 billion to banks and other financial institutions.


While the ECB “has had one eye on the exit since the start of the crisis,” it nonetheless appears to be in no hurry to hike rates – neither its overnight nor its refi rate. Jean-Claude Trichet himself has said, “The current rates are appropriate.” He even refused to rule out the possibility that rates could even fall further before policy is tightened.

According to a Bloomberg survey of economists, this won’t happen for at least a year – the fourth quarter of 2010 to be specific. After all, inflation has touched a record low of -.1%. The Eurozone economy contracted by a record 4.5% last quarter. Private sector lending growth has fallen to a record low of 1.8%. All in all, not exactly the right environment for a rate hike. There is at least one vocal inflation hawk on the governing board of the ECB who is arguing for preemptive rate hikes, but for now at least he has been silenced. “Economists at Barclays in London have forecast that Europe’s policy makers won’t begin raising rates until late 2011.”

The forex markets, meanwhile, appear to be indifferent to this whole debate, concerned not about Eurozone growth, inflation, low interest rates, not to mention political uncertainties and trade deficits. The Euro has resumed its upward rise against the Dollar, begun in March, and may not slow down until the Fed starts to tighten monetary policy.


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Will the Euro Survive the Credit Crisis?

Jul. 3rd 2009

The Euro has always had a marginal group of naysayers; there were always those who insisted that a common currency didn’t make sense for a region as diverse as the EU. As a result of the credit crisis, a bevy of critics have come out of the woodwork and declared that the Euro will not survive its first official crisis. Are they right?

According to a Special Report on the Euro Area published in the Economist (which inspired this post), the Euro has been a modest success by most measures. “The ECB has fulfilled its remit to maintain the purchasing power of the euro. Since the currency’s creation the average inflation rate in the euro area has been just over 2%. Fears that the euro would be a “soft” currency have proved unfounded. It is unquestioningly accepted at home and widely used beyond the euro area’s borders.” While the Euro hasn’t facilitated meaningful gains in productivity or GDP, it has unquestionably engendered greater stability.


Ironically, the countries that are now complaining the loudest about the Euro are mainly those that benefited the most from its membership. The economy of Spain, for example, “grew at an average annual rate of 3.9% between 1999 and 2007, almost twice the euro-zone average and much faster than in any of the currency area’s other big countries…Unemployment fell from close to 20% in the mid-1990s to just 7.9% in 2007.”

Unfortunately, the economic boom also corresponded with a rise in prices and unit wage costs, both of which are now proving to be particularly painful in the context of recession. Aided by a strong currency, its current account deficit has risen to 10% of GDP. Meanwhile, the same problems are affecting Portugal, Ireland, Italy, and Greece. As the report explains, “The main hazard for investors in high-inflation countries—that a steady loss of domestic purchasing power will drag the currency down—is eliminated in a fixed-exchange-rate zone.”

A country with an independent monetary authority would normally deal with these problems by raising interest rates and/or devaluing the currency. Actually, given how extreme the imbalances are in some of these countries, the markets probably would have accomplished this for them. In this case, however, their membership in the EU and their deference of monetary power to the European Central Bank precludes such possibilities. As a result, the main solutions will have to be originate in the political arena. Wages will have to become more flexible, and labor market controls will have to be loosened, in order to increase productivity.

The alternative – leaving the Euro zone- is unthinkable. “The costs of backing out of the euro are hard to calculate but would certainly be heavy. The mere whiff of devaluation would cause a bank run: people would scramble to deposit their euros with foreign banks to avoid forced conversion to the new, weaker currency. Bondholders would shun the debt of the departing country, and funding of budget deficits and maturing debt would be suspended.” As a result, borrowing costs would increase drastically, which could induce a wage-price spiral. Inflation and currency stability would be tenuous, at best. As a result, it’s not surprising that in most Euro member states, polled citizens remain strongly in favor of the Euro.


In addition, those on the cusp of joining remain firmly committed to doing so. For such economies, the economic crisis has actually strengthened the case for Euro membership. “As emerging economies they are prone to sudden shifts in foreign-investor sentiment, which makes for volatile currencies, so exchange-rate stability holds considerable appeal for them.” Romania and several baltic states have already had to go hat-in-hands to the EU and IMF to ask for assistance in order to stave off a complete loss of investor confidence. Poland is also vulnerable to currency decline, since many of its loans are denominated in foreign currency; it is currently aiming for Euro membership in 2012.


Concludes the Economist, “For all its shortcomings, the euro zone is far more likely to expand than shrink over the next decade. Most EU countries that remain outside, bar Britain and Sweden, are eager to join.” This is certainly a bit glib, and ignores the imbalances that the currency is at least partially responsible for. Still, the tentative consensus is accepting of the Euro. It’s like the old joke about capitalism – “it’s the worst system– except for all of the others…”

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General Uncertainity Pushes Dollar Upwards

Jun. 19th 2009
Over the last month, the US Dollar has steadily reversed its downward fall against the Euro. While it might still be premature to pronounce an end to the amalgam of intertwined trends that sent equities, commodities, and emerging market currencies (i.e. anything risky) up and the Dollar down, it’s worth examining this possibility in greater detail.
My philosophy of forex has always been to focus on the medium and long-term trends. Over the last two two-three months, the medium-term narrative was one of increased risk-taking. Generally, investors had become both more complacent with risk and more optimistic about the global economy’s prospects for avoiding economic depression. The US financial sector was shored up (or at least “vouched for”) by the US government, and a Fed-driven flood of liquidity poured money into the riskier sectors of the global financial markets.
The sideways trending of the USD/EUR doesn’t necessarily imply that this trend has run its course. Instead, I think it suggests that investors are looking for guidance as to what kind of narrative will predominate over the next few months- whether a continuation of the risk-aversion story, or a brand-new story. Investors tend to make their own reality, such that a pattern will inevitably emerge, and investors will find cause to affirm that pattern or negate that pattern. Simply, right now, there is no consensus on what that pattern is.
There is good reason for caution. The global economy (and forex markets) stand at a crossroads. Investors (want to) believe that the worst of the recession is behind us. But there is still good reason to believe that this is not the case. Unemployment is still rising, the housing market is falling, and GDP is still declining. Stock market investors may finally have taken notice of this contradiction, as the stock market rally has stalled of late.
Meanwhile, long-term rates have begun to tick up, but short-term rates remain frozen at record lows. Some analysts believe that the Fed will tighten monetary policy before the year is out, but the wide daily swings in interest rate futures contracts, imply a complete lack of consensus on this as well. The same goes for inflation, which is near 0% at the moment, but could easily explode as a result of rising recovering prices, record budget deficits, and the Fed’s own quantitative easing program.
There is no single event or data point that will shake investors from their uncertainty. Sure, a credit downgrade of US sovereign debt, another large-scale bankruptcy, a strong intimation of an interest rate hike, or a turnaround in GDP would all do the trick. In all likelihood, however, it won’t be so obvious, and investors will continue to selectively cull data that reinforces the case for optimism, pessimism, or further uncertainty.
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Posted by Adam Kritzer | in Euro, Investing & Trading, News, US Dollar | 2 Comments »

Politics Weigh on the Euro, but Overshadowed by Other Factors

Jun. 15th 2009

With interest rate differentials, growth trajectories, and risk aversion weighing on (forex) markets, there’s no room in the picture for politics. I preface this post accordingly because current market dynamics are such that even the most dramatic political developments (short of the breakup of the EU) would probably be brushed aside. The long-term, however, is a different story, and investors ignore politics at their peril.

By its very nature, the Euro is perhaps most vulnerable to the vicissitudes of politics. The last week alone brought two significant developments: the downgrading of Ireland’s debt, and a crisis in Latvia. The former weighed directly in the Euro, while the latter probably didn’t have much of an effect. The reason being is that investors viewed the Irish downgrade as a possible precursor to downgrades in other EU economies. Spain and Italy, for example, are in equally precarious positions, and a 6% decline in GDP means German probably isn’t that far behind. In other words, investors may have to rethink their implicit assumption that the EU is currently less risky than the US.

EU government debt 2009
But how do you square fiscal instability against monetary instability? The US is printing money, but EU member states are (marginally) more likely to go broke. Is inflation more conducive to currency devaluation that sovereign bankruptcy? Perhaps the logic is that inflation is acceptable (albeit undesirable) whereas a large-scale default would shake the global financial system to its core; this being the case, it’s probably more practical to bet on the former.

The crisis in Latvia, meanwhile, came in the form of sudden pressure on currency to devalue its currency (known as the Lats), which is pegged to the Euro. The crisis only affects the Euro indirectly vis-a-vis the currency peg and any exposure that European investors have to Latvia. Thus, the Euro wouldn’t drop much as a result of a Latvian currency devaluation, even though the consensus is that such would be “bad” for everyone. For example, it would “trigger a wave of bankruptcies because 80 percent of private borrowing is in euros.”

The crisis is mainly relevant in that it has turned into a framing point for the future of the Euro, which Latvia is slated to join in 2012. “Euro zone entry would recede since the country would have to restart from scratch in the EU’s Exchange Rate Mechanism (ERM) with higher inflation and a bigger budget deficit.” Given that the EU is already slightly unstable (see above for example), why would it want to bring even more unstable economies into the fold of the Euro?

“There is some suspicion that Germany, the EU’s central economy, may want to slow down euro zone enlargement to preserve stability for existing members and perpetuate its orthodox influence over European Central Bank decision-making.” Still, “The EU is a community of law. Treaty rules for joining the single currency cannot simply be torn up in a crisis to admit countries in distress.” In short, there are compelling arguments for both sides. Analysts should watch closely, as the treatment of Latvia (i.e. whether the ECB bends over backwards to help it stay on track) will show how serious the EU is about spreading membership to the rest of Europe.

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Euro Rises Despite EU Economic Malaise

May. 25th 2009

Their is no way to sugarcoat it; the EU economy is in poor shape, and is steadily worsening. In the most recent quarter, it contracted by 2.5%, most in at least 13 years. [It very well could have been the worst quarter in 50 years, but Eurozone economic data was only compiled beginning in 1996].

Germany’s economy is leading the pack (downwards), having contracted by 3.8% in the most recent quarter, and by 7% since the recession officially began. Compared to similar declines in other economies, “The 1.2% fall in France, large by any normal standards, almost counts as a boom,” quipped The Economist. It turns out that many of the EU’s headline economies were especially dependent on exports and/or housing to drive growth, both of which have been annihilated by the credit crisis. “One of the ironies of this downturn is that it was caused by global housing and credit busts, and yet the economies that have suffered most, such as Germany and Japan, sat out the credit boom.”

Still, some economists continue to wear rose-tinted glasses: “Hopes rose…that the worst could be over for Germany’s economy as a closely-watched index measuring the confidence of financial market players rose to a near three-year high in May, its seventh consecutive monthly gain.” Added Axel Weber, a member of the ECB’s governing council, “‘There is definitely hope that the euro zone economy will gradually stabilise in the later part of 2009.” A more realistic analyst responds: “That points not to a revival but rather to a slower rate of GDP decline in the present quarter (it could scarcely get worse).” To prove that economists truly create their own reality, another confidence indicator that was released on the same day fell to a six-year low.

Other analysts have found solace in EU labor markets, which remain relatively buoyant due to a lack of flexibility in hiring and firing. In fact, “Unemployment in the United States has risen to European averages, and seems likely to pass them when international data for April is calculated.” While this might be good news for workers, however, it negatively impacts GDP growth by preventing the economy from returning to a stable production base.

eu unemployment rate

The Euro, meanwhile, has never been stronger. It has risen over 10% since touching a low against the Dollar on March 10, and recently broke through an important psychological barrier of $1.40. There are couple of explanations for this “contradiction.” The first is simply an application of the risk-aversion narrative. Simply put, “the euro is generally considered a risky bet on currency markets and therefore gains at times when there is greater perceived economic stability.” Recent trends suggest that financial market stability is more important than economic stability in the eyes of investors, but the idea is the same.

The other explanation concerns inflation, or rather the lack thereof. The European Central Bank’s response to the credit crisis has been much more restrained than its counterparts, most of which are pumping money into credit markets with little concern about the future implications. Sure, the ECB has authorized a program to extend low-interest loans to member banks, and plans to purchase up to $80 Billion in corporate bonds, but these measures pale in comparison to what the Fed and BOE have announced.

The ECB has also opted not to cut rates all the way to 0%, electing instead to hold its benchmark at 1%. Jean-Claude Trichet, head of the ECB, recently underscored that the role of the ECB is primarily to guard against inflation, rather than stimulate economic growth. “We are there to deliver price stability and price stability in the medium term is a crucial element in activating confidence,” he said. While there is certainly room for the debate as to whether this is economically sensible, Euro bulls can rest assured that their currency is being actively protected.


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Posted by Adam Kritzer | in Central Banks, Economic Indicators, Euro, News | 1 Comment »

Euro Continues to Rise, but Technical Obstacles Exist

May. 20th 2009

Over the last couple months, the Euro has thoroughly outperformed the Dollar, which recently fell to a five-month low on a trade-weighted basis. Over the same period, global stock and commodity prices have also risen quickly, which is not a coincidence.
Euro Rallies against DollarIn other words, investors are allocating capital on the basis of risk, rather than in accordance with (economic) fundamentals. For example, “ICE’s Dollar Index and crude oil have a correlation of minus 0.61 in the past two months, compared with minus 0.26 since the start of the year,” as rising oil prices and the declining Dollar feed back into each other.

Meanwhile, “Implied volatility on major currencies, which reflects investors’ expectations of currency swings, fell to 13.96 percent yesterday, from…17.22 percent at the end of March. A drop in volatility tends to signal less demand for options to protect investors from currency swings.” This indicator is now at its lowest level since the days preceding the Lehman Brothers bankruptcy and subsequent stock market collapse. One would normally expect a correlation between risk and return, but in this case, rising returns have been accompanied by lower risk.

Even more unbelievable is that this decline in risk is taking place against the backdrop of declining economic fundamentals. “Risk appetite in the currency market is nothing short of impressive considering the fact that the Fed reduced their growth forecasts,” said one analyst. However, “The euro-area economy will contract 4.2 percent this year, according to the International Monetary Fund, more than the projected 2.8 percent contraction in the U.S. and 4.1 percent slump in the U.K.” If investors were focusing on this divergence in economic growth, one would expect the Euro would be falling.

One hypothesis is that inflation-conscious traders are flocking to the Euro, since the ECB remains vigilant about fighting inflation, even in the face of declining prices and aggregate demand. After cutting rates to a record low 1% earlier this month, the ECB unveiled its own version of a quantitative easing plan, involving the purchase of 60 billion euros worth of low risk securities. But this is a pittance, both relative to the size of the EU economy (it represents a mere .6% of GDP) and compared to the Trillion Dollar Fed program. This led one analyst to call the ECB’s plan “chicken feed.” While all of this is noteworthy, it’s unlikely that this is having a meaningful effect on forex markets, which still remain focused on (avoiding) deflation.

If the Euro is to continue rising, it must overcome some technical obstacles. “The euro could hit a ceiling if the recent resilience of U.S. stock markets faces headwinds. ‘At some point…stronger nongovernment growth has to show up to sustain and justify these moves in equities.’ ” It’s interesting that the fear of Euro bulls is not that the EU economy won’t recover, but rather that US stock prices are overvalued. Given recent market movements, however, their concerns are reasonable, and “any disappointment [in corporate fundamentals] could provide an excuse to take profit [this] week — benefiting the dollar.”

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Euro Resumes Decline After Brief Pause

Apr. 28th 2009

The one-year chart of the EUR/USD depicts a general downward trend, punctuated with steep “blips.” Every couple of months or so, it seems traders are temporarily jarred loose from their mindset of Euro bearishness, and find an excuse to bid up the common currency. Invariably, the Euro then resumes its downward course a few weeks later.
The Euro’s recent trading activity fits this mold perfectly. The global stock market rally in March was accompanied by a spike in the Euro. While equities, commodities, and even other currencies continued to rise, however, the Euro peaked after a couple weeks and has since hovered around the $1.30 mark.  As one currency strategist summarized: “A breakdown of the correlation between the euro-dollar exchange rate and the S&P index indicates the currency pair ‘ has become a trade that is less about risk, a little more about euro rate specifics.’ ”

In other words, the decline in risk aversion has not expanded to include the Euro. This is somewhat surprising, since EU economic indicators have rebounded in the last month. The oft-cited German IFO index “rebounded from a 26-year low,” while “retail sales declined the least in 11 months in April after government stimulus packages improved consumer confidence.” On the other hand, EU lending activity, which is more correlated with economic growth, continues to decline. “The European Central Bank Wednesday released figures showing that banks in the currency area cut their lending to both companies and households in March.”

This is a huge problem for the EU, where the banking sector represents a comparatively important component of the economy.. “At the end of 2007, the stock of outstanding bank loans to the private sector amounted to around 145 percent of gross domestic product, compared to 63 percent in the United States.” This is belied by newspaper headlines that maintain the banking crisis is most severe in the US. In nominal terms, this might be true, but in relative terms, the EU is in much worse shape. Given that exchange rates are all relative, it is worth paying attention to this phenomenon.

The ECB is doing all that it can to help the situation, but many analysts and even some of the Bank’s own members remain critical. “The ambiguity of the ECB’s stance is not helping [the Euro,” offered one analyst. The ECB’s next meeting is scheduled for May 7, when economists predict the benchmark lending rate will be lowered to 1%. This will appease some investors, but not all. The head of Germany’s IFO organization, for instance, has urged the ECB to slash rates down to .25%.

As ECB President Jean Claude Trichet has pointed out, lower rates will not automatically stimulate the economy: “Owing in particular to the very low rate on our deposit facility of 0.25 percent, this difference in policy rates doesn’t translate into equivalent differences in money market rates.” In fact, money market rates have largely converged across the EU and US, despite the divergence in short-term rates, vindicating Trichet.

More important, then is the ECB’s non-monetary initiatives. To quote Trichet again, “Comparing only the levels of policy rates without consideration of the resulting market rates and other economic variables is looking at just one part of a far broader canvas.” The Economist recently published an excellent comparison of the various Central Banks’ responses to the credit crisis. While some have embraced their newfound prominence, other Central Banks have shied from the spotlight, insisting that their mandates are limited to inflation targeting. The ECB probably falls into this category, as it has thus far stood on the sidelines – for better or worse- as its counterparts have turned on the printing presses and flooded their respective credit markets with liquidity. [Chart courtesy of The Economist].
This could soon change, and “A commission headed by Jacques de Larosière, a former head of both the Bank of France and the IMF, has recommended that the ECB chair a new European Systemic Risk Council made up of its member central banks and supervisors.” Not all investors are convinced that the ECB can successfully break with tradition. “Alan Ruskin, head of international currency strategy in North America at RBS Securities…recommends investors sell the euro on ‘upticks’ as the ECB abandons ‘monetary orthodoxy’ and uses unconventional measures to spur growth.”

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Posted by Adam Kritzer | in Central Banks, Euro | No Comments »

Euro Gains after ECB Rate Cuts

Apr. 4th 2009

Yesterday, the European Central Bank delivered a surprise to the forex markets; instead of cutting rates by the consensus expectation of 50 basis points, the ECB knocked down its benchmark lending rate by only .25%. The Bank also opted against certain non-standard measures that would accompany a change in monetary policy. At this point, all investors can do is wait until the next meeting to see if the ECB will finally intervene in credit markets as well as on behalf of beleaguered Eastern European currencies.

While Jean-Claude Trichet, President of the ECB, coyly refused to rule out the possibility of further rate cuts, analysts are puzzling over the relatively minuscule cut. After all, the consensus was that the ECB had already fallen well behind the curve, and was not struggling as quickly as possible to play catch up with its counterparts in the UK, US, and Switzerland. “ ‘By again buying time, the ECB risks falling further behind the curve…You cannot buy time forever.’ ”

ecb-lowers-rates-in-2009There are a few explanations. First of all, it’s possible that the ECB is selectively interpreting data as a basis for deriving a more optimistic economic forecast. Given the spate of recent bad news emanating from Europe, however, this seems unlikely. Besides, no less than Trichet himself has suggested that an economic recovery is unlikely to occur before 2010. There is also the possibility that the ECB is simply prioritizing its mandate to guard against inflation, rather than to stimulate economic growth. This theory is also unconvincing, given that price inflation has already fallen well below the ECB’s target of 2%.

Perhaps, the best explanation is technical: “A 50 basis point cut would have required the ECB to cut the interest that it pays on deposits by banks to zero, from 0.5%, in order to maintain the current spread between the two of 1 percentage point.” Along the same lines, “European interest rates are lower than those in the U.S. when making a comparison of real inter-bank lending.” Ultimately, it’s probably the Bank’s conservatism that is behind both its comparatively tight monetary policy and its failure to unveil a quantitative easing plan that would mirror those put forth by the Fed and Bank of England. In other words, the door for more drastic monetary prescriptions has been strategically left open in the EU, while all but closed in the US and UK.

Curiously, the “the smaller-than-expected rate cut ‘remains an all-round booster for the single currency.’ ” Prevailing trading patterns and market sentiment seemed to herald a decline in the Euro, as investors have recently prioritized capital preservation and vigilance against deflation. Based on the positive market response, however, we can conclude that there are still some traders for whom interest rate differentials are important. After all, the only remaining alternatives to the EU (from the standpoint of yield) are Australia and New Zealand, but both of these economies/currencies are perceived as risky.

Alas, the ECB’s role is not to make currency traders happy. Unless the ECB follows up with a big move next month, the result could be a “very prolonged slump in euro-zone activity.”

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Posted by Adam Kritzer | in Central Banks, Euro | No Comments »

ECB Prepares to Lower Rates, Euro Rally Fades

Mar. 30th 2009

On Thursday, the European Central Bank will conduct its monthly monetary policy meeting. The consensus among analysts is that the meeting will lead to a 50 basis point cut, leaving the EU’s benchmark lending rate at 1%, a record low. Investors are also bracing for the ECB to announce certain unconventional steps, similar to the Fed’s program of quantitative easing, although not to such an extent. Analysts have speculated that the ECB “could intervene in bond markets to help ease companies’ financing problems.”

This marks an about-face from current policy and recent rhetoric, in which the ECB insisted that guarding against inflation was more important than providing economic stimulus. In fact, Jean-Claude Trichet, President of the ECB, has recently found himself on the defensive: “I don’t think it is justified to say we are doing less on this side of the Atlantic. We have automatic stabilizers,” he said during his quarterly testimony in front of European Parliament. In fact, the ECB had become an outcast among Central Banks for waiting a long time before finally agreeing to cut interest rates. Since embarking on a program of monetary easing, it has been playing catch-up by cutting rates at breakneck speed.

It appears that the ECB’s arm was twisted by the most recent economic data; a sudden drop in German manufacturing suggests that the recession is both spreading and deepening. Combined with a record drop in the EU economic sentiment, this “suggests that the euro zone economy will have contracted by roughly 2 percent quarter on quarter in the first three months of the year.” In addition, both producer and consumer prices have eased, such that inflation has fallen well below the 2% target level, and the ECB lost its last excuse for not dropping rates.

As a result both of the worsening economic situation, as well as the projected decline in yields, currency traders are once again questioning the Euro. The last couple weeks have been rife with commentary that the Dollar rally had come to an end as a result of the intensification of the Fed’s plan to use newly printed money to as a source of liquidity in the credit markets. “The dollar’s traditional trading patterns have been altered in the wake of new U.S. quantitative-easing measures. Risk appetite, stocks and funding currencies appear to hold lesser influence lately.”


This week, the narrative in forex markets favors the Dollar. It could be that the safe-haven trade has returned to lift the Greenback, but more likely is that investors are comparing economic fundamentals when making bets on currencies. One analyst summarized his firm’s position as follows: “We have argued that the leveraging-de-leveraging axis has been the key driver in the foreign exchange market. We expect a new driver, anticipated growth trajectories, to emerge…[and] for the dollar’s uptrend to resume in the second quarter.”

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Posted by Adam Kritzer | in Euro, US Dollar | 3 Comments »

USD/EUR: Conflicting Signals Make Predictions Difficult

Mar. 24th 2009

If you read analysts’ coverage of the Dollar decline (and consequent Euro rally), there is an even divide over whether it is sustainable. Economic data and technical indicators paint a nuanced picture, such that this kind of uncertainty is understandable.
On the one hand are the the Dollar bears, who point to an economic recession that continues to deepen, and the seeming complacency of the Federal Reserve Bank towards inflation. If there is any doubt as to how the forex markets feel about the Fed’s plan to purchase over $1 Trillion in US government bonds, consider that the the Dollar just recorded its worst weekly performance in 24 years, while the Euro simultaneously recorded its strongest week since its inception in 1999. There’s not much nuance there.

Meanwhile, the economic picture is equally depressing. Summarized by Kathy Lien of GFT Forex:

The Empire state manufacturing survey plunged to a record low in the month of March while Industrial production fell 1.4 percent, driving capacity utilization back to its record lows.  Foreign investors reduced their holdings of U.S. assets by the largest amount since August 2007. Homebuilder confidence held near its record lows in the month of March as the slump in the real estate sector shows no signs of easing.

Unfortunately, there is a contradiction in the argument that the Dollar is being plagued both by economic collapse and by the risk of inflation. Writes Marc Chandler, head of FX strategy at Brown Brothers Harriman, “The pessimist camp wants it both ways. The US is going down the same path as Japan, where the end of a real estate bubble led to a banking crisis and a deep economic contraction. And they want to caution that printing of money will boost interest rates, fuel inflation and debase the currency.” He points out that history, as well as common sense, contradict this line of thinking.
Those that remain bullish on the Dollar argue that the Euro rally is a function of technical, rather than fundamental developments. First of all, we are approaching the end of a fiscal quarter. As evidenced by the Dollar decline which took place at the end of December, these periods are usually marked by portfolio rebalancing and hedging, such that it’s not uncommon to see large swings in forex markets. From a technical standpoint, when the Dollar failed to breach the $1.30 level against the Euro, many short sellers were probably forced to cover their positions, which accelerated the Dollar’s decline.

Bulls are confident that the pickup in risk-taking which catalyzed a 20% stock market rise is here to stay. “The move to the upside came after the government described a plan that will…generate $500 billion, and possibly $1 trillion over time, to buy hard-to-trade and badly deteriorated assets from banks.” The banks will be recapitalized, the financial system is being repaired, and everything will be okay, right?

The markets are certainly prone to false-starts. I can count numerous instances of government officials and market commentators insisting that “the worst is behind us.” Nevertheless, if this time proves to be different, it could be bearish for the Dollar, whose role as ‘safe-haven’ currency would likely be eroded by a positive change in market sentiment.

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Posted by Adam Kritzer | in Economic Indicators, Euro, US Dollar | 6 Comments »

The Split Yen

Mar. 9th 2009

The Japanese Yen is increasingly resembling a patient with split personality disorder, moving in one direction (down) against the Dollar while behaving quite differently against other currencies.


For most of the duration of the credit crisis, the Yen had mirrored the performance of the Dollar, both of which had performed well as so-called “safe-haven” currencies. For a while, the Yen even outpaced the Dollar, rising to a 13-year+ high. Over the last five weeks, however, the Yen has fallen off against the Greenback, while maintaining its value against other rivals. It’s unclear exactly what’s driving this split, but careful analysis suggests it is a product of changed investor psychology.

To elaborate, the Yen’s precipitous rise was due to financial- as opposed to economic- factors. As investors fled emerging markets en masse and unwound carry trades, it spurred a flood of capital back into Japan. This was not because the Yen was anything special; far from it, in fact. Rather, it was because the alternatives were perceived to be substantially more risky. This began to change in earnest when it was revealed that the Japanese economy shunk by over 12% (on an annualized basis) in the recent quarter. Given that Japan’s economy is famously dependent on exports, it didn’t take long for investors to connect Japan’s sagging GDP with its strong currency.

This prompted speculation that Japan would intervene in forex markets in order to prevent the Yen from rising further. In the end, Japan didn’t spend a dime. Fortunately, it didn’t have to, as investors took the hint, and sent the Yen tumbling against the Dollar. Technically, Japan hasn’t intervened since 2004 (see chart), but the threat of intervention combined with low interest rates ensured that in this case, words spoke just as loud as actions. It should be noted that Japan will use a small portion of its reserves to fund domestic economic initatives, but for now at least, none of it will be used to purchase Dollars in the spot market.

So why hasn’t the Yen reversed course against other currencies? Its stock market is sagging, and its economy is in equally bad, if not worse-than-average shape. The answer lies in interest rate differentials and investor risk tolerance. The rate gap between the Yen and the highest-yielding currency (New Zealand), has shrunk to less than 3.5%. Excluding Australia, and to a lesser extent the Euro, interest rate differentials are effectively negligible. Accordingly, investors have decided that the gains from an additional couple hundred basis points in yield are not offset by the perceived increase in risk associated with currency volatility. That this theory holds water is evidenced by the fall in the Japanese Yen that immediately registered when the Bank of Australia opted to hold rates steady at its most recent meeting.

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Posted by Adam Kritzer | in Euro, Japanese Yen, US Dollar | 1 Comment »

UK, EU Central Banks Follow the Federal Reserve

Mar. 6th 2009

Yesterday, both the European Central Bank (ECB) and the Bank of the UK cut their benchmark interest rates to record lows. This is especially incredible in the case of the UK, whose Central Bank over 300 years old! You can see from the following chart that both Central Banks have more than made up for their respectively slow starts in easing monetary policy by effecting several dramatic rate cuts, following the example of the Federal Reserve. The baseline UK rate now stands at .5%, only slightly higher than the Federal Funds rate, and slightly lower than the 1.5% ECB rate.

Given that they have essentially reached the terminus of their monetary policy options, all three Central Banks are exploring further options aimed at pumping money into their respective economies. The Fed has already “announced a program to buy $100 billion in the direct obligations of housing related government sponsored enterprises (GSEs) — Fannie Mae, Freddie Mac and the Federal Home Loan banks — and $500 billion in mortgage-based securities backed by Fannie Mae, Freddie Mac and Ginnie Mae.” As I wrote in a related article, “this was quickly followed by repurchase programs, lending facilities, investments in money market funds, and option agreements, all of which were designed to supplement its ‘traditional open market operations and securities lending to primary dealers.’ The Fed’s efforts also worked to ease the liquidity shortage in credit markets abroad by entering into swap agreements with several foreign Central Banks suffering from acute Dollar shortages.”

In conjunction with the rate cut, the Bank of the UK, meanwhile, will pump £150bn directly into UK credit markets through liquidity support, buying public and private debt, and asset purchases. “The main purpose of quantitative easing is not to send the money supply into orbit but to stop it from crashing…the broad money held by households has risen at a worryingly slow rate over the past year, and holdings by private non-financial firms have actually been dropping.” In contrast to the monetary programs of the UK and US, the ECB has thus far refrained from the kind of liquidity support that would necessitate printing new money. Instead, “the central bank will continue offering euro-zone banks unlimited loans at the central bank’s policy rate until at least the end of this year.”

The interest rate cuts were announced simultaneously with a spate of macroeconomic data, which collectively paint a bleak picture. Eurozone growth is projected at -2.7% for 2009 and 0% for 2010. The current unemployment rate at 8.2% and climbing. The thorn in the side of the EU is represented by eastern Europe, where growth is falling at an alarming pace, dragging the EU down with it. While EU member states have pledged to intervene if one of their own falls into bankruptcy, it’s unlikely that they would intervene similarly if a non-EU member state went bust. The UK economy is similarly desperate, having contracted at an annualized rate of 5.8% in the most recent quarter. The wild cards are the real estate and financial sectors, the fortunes of which are increasingly intertwined.

So what do the forex markets have to say about all this? Economists have used the dual phenomena of risk aversion and deflation to explain the interminable weakness in the the Pound and Euro. Everyone is surely familiar with the notion of the US as “safe haven” during periods of global financial instability. The deflation hypothesis, meanwhile, suggests that the ECB (and to a lesser extent, the Bank of UK), fell behind the curve when easing liquidity. The ECB, especially has harped on inflation as a reason for cutting rates more quickly. Given that investors are now more concerned with capital preservation than price inflation, it follows that they would prefer to invest where Central Banks were more vigilant about deflation (i.e. the US).

Personally, I think that the continued declines in both currencies, in spite of steep interest rate cuts, indicates that the deflation hypothesis is bunk, and investors remain fixated on risk aversion. By no coincidence, the temporary rebound in US stocks that took place in January was also accompanied by a bump in the Euro. (See chart below).

I think this mindset is reasonable, but only in the short-term. Given the current economic environment, I don’t think investors (and currency traders) can be faulted for ignoring the possibility that quantitative easing and liquidity programs will have to be funded with the printing of new money, which would be inherently inflationary. Many comparisons are being made with Japan, whose ill-fated quantitative-easing program succeeded only in inflating a bond-market bubble and vastly increasing Japanese public debt. According to one columnist, “it’s hard to argue that quantitative easing ended deflation; high oil prices did that. Meanwhile, the economy cured on its own most of the structural problems such as excess capacity and too much debt associated with the deflationary environment.”

In short, with a medium and long-term investing horizon in mind, I think the ECB’s approach to dealing with the credit crisis is more conducive to monetary stability. Thus, when investors grow weary of the idea of US as safe haven, they will no doubt focus instead on fundamentals. At which point, the ECB will likely be rewarded for fulfilling its anti-inflation mandate, in the form of a stronger Euro.

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Posted by Adam Kritzer | in British Pound, Central Banks, Commentary, Euro | 7 Comments »

Eastern Europe Plagued by Currency Instability

Feb. 23rd 2009

The credit crisis continues to exact a devastating toll on the economies of Eastern Europe, and capital flight has caused the region’s currencies to plummet precipitously. This has prompted internal debate in countries such as Poland, Czech Republic, and Latvia – to name a few- as to whether the effects of the crisis would have been so blunt had they adopted the Euro. While certainly Euro membership would have spared them from currency instability, it would not have necessarily facilitated financial and economic stability, as Italy, Spain, and Greece have learned the hard way. Regardless of whether Eastern European countries are politically willing to commit to the Euro (itself doubtful), this debate is largely moot, since the credit crisis has all but eliminated their ability to meet the preconditions of membership in the short run. The New York Times reports:

The Baltic states would like to join as quickly as possible, but their economies are contracting so much that it would be impossible to meet the criteria, which, among other things, stipulates that budget deficits should be below 3 percent of gross domestic product.

Read More: Currency Issues Weigh on Eastern Europe

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Posted by Adam Kritzer | in Emerging Currencies, Euro, Politics & Policy | 4 Comments »

ECB Hints at Rate Cut

Feb. 18th 2009

At its next meeting, to be held in March, the European Central Bank is all but certain to bow to pressure and cut its benchmark interest rate to a record low. This should not come as a surprise, for the ECB’s February decision to hold rates constant was met with a large outcry, in both public and private circles. Soon-to-be-released inflation data is expected to confirm that prices are rising at a slower pace, perhaps even below the ECB’s 2% benchmark. Members of the Bank are also paying attention to the Euro, the continued weakness of which is ironically a product of the ECB’s comparatively tight monetary policy, as investors guard themselves against the risk of deflation. The Guardian reports:

As the economy falters, speculation is also increasing that the ECB may expand its monetary toolbox, possibly through asset purchases, to boost growth while keeping rates relatively high compared to other central banks.

Read More: ECB’s Liikanen, Bini Smaghi say rates could move in March

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ECB Holds Rates

Feb. 6th 2009

After "profound" debate, the European Central Bank voted yesterday to hold its benchmark interest rate constant at 2%. Despite the acknowledged fact that EU inflation has slid to the lowest level in a decade, the ECB remains unconvinced that it has been tamed. It is apparently concerned that further interest rate cuts could trigger a loss of confidence and hyper-inflationary spiral, from which it would be difficult to escape. The Bank's critics, meanwhile, insist that it is increasingly out of touch with economic reality and is falling further behind the curve, especially compared to the Fed and bank of England, which have already lowered rates to record lows. They further argue that this viewpoint is reflected in the Euro, which is losing the battle as safe haven currency with the Dollar. Nonetheless, it appears that investors accept the reasoning of the ECB, and the Euro reacted to the rate hold with indifference. The Financial Times reports:

The ECB president…said only that a zero interest rate policy had a “number of drawbacks” that should be avoided, without specifying what they were.

Read More: ECB halts rate cut after profound debate

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EU Periphery Laments Euro Membership

Jan. 30th 2009

Only last year, Greece, Ireland, Italy, Portugal and Spain were collectively the pride of the EU, boasting strong growth characteristics and buoyant capital markets. In hindsight, this was but a mirage, as the stability of Euro-membership allowed such "peripheral" economies to embark on a colossal building boom and spending spree that was ultimately baseless. Greece, which is perhaps in the worst shape of the lot, witnessed its twin deficits (government debt and trade) rise to dangerous levels; given its membership in the EU, it is unable to resort to currency depreciation to rectify the problem.

The illusion has since been shattered, and it seems investors are trying to overcompensate for their previous naivete. Yields on government bonds for all five countries have begun to creep up, and a handful of speculators are betting on the possibility of default. Most experts insist that such a scenario is unlikely, but at the very least, the credit crisis has exposed the chinks in the armor of the EU, demonstrating that the currency also has its drawbacks. The New York Times reports:

While sharing a currency with some of the mightiest economies in the world helped Europe's poorer nations share in the wealth, a boon during boom times, in hard times the rules of membership are keeping them from doing what countries normally do to ride out economic storms, including enormous spending.

Read More: Once a Boon, Euro Now Burdens Some Nations

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The Euro Paradox

Jan. 26th 2009

The deepening of the credit crisis in the EU has triggered a wave of self-reflection, prompting those on the inside to ponder life without the Euro and those on the outside pondering life with the Euro. Their opinions couldn't be any more divergent. Countries like Italy, Spain, and Ireland, for example, have blamed the Euro for their economic woes, arguing that easy monetary policy and cheap credit were responsible for their real estate bubbles. Some commentators, accordingly, have argued that structural differences between these countries and the economic powerhouses of Germany and France are so large that it doesn't make sense for them to share a common currency. Meanwhile, Eastern European countries, most of which are still outside the Euro, are clamoring to join as sudden depreciations in their respective currencies have exposed them to massive economic instability. Business Week reports:

What happened, in effect, was rapid economic isolation. This began as investors moved money from more risky regional stock and currency markets into safer, often euro-denominated, assets, in what economists call a "flight to quality."

Read More: The Euro's Growing Appeal

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ECB is Behind the Curve

Jan. 19th 2009

At the beginning of last week, analysts predicted that the Euro would continue to fall, on the basis of a deteriorating economic situation and the likely consequence of an expected ECB rate cut. Sure enough, the data indicated a decline in both inflation and economic output, paving the way for a 50 basis point cut in the ECB's benchmark lending rate and a fall in the Euro. Unfortunately, the consensus among analysts is that the common currency is poised to fall further. Investor interest in European assets and securities is waning rapidly as a result of a increased credit/economic/currency risk and decreased yield. In addition, the ECB is probably "behind the curve," having waited longer than its counterparts in the US and Britain to ease monetary policy. The Wall Street Journal reports:

"The sentiment is that the ECB is required to play catch-up in cutting interest rates," said Robert Blake, a Boston-based senior currency strategist at State Street Global Markets. "This could lead to further downward pressure on the euro for some time to come."

Read More: Euro Poised to Fall on Rate Cuts

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British Pound Oversold?

Jan. 16th 2009

Last week, the British Pound recorded its strongest performance against both the Dollar and Euro in nearly 20 years, on the basis of both technical and fundamental factors. On the surface, the Bank of England interest rate cut that prompted the rally would seem to be be negative for the Pound, since lower yield makes Britain a less attractive place to invest. On a deeper level, the relative modesty of the rate cut signalled to investors that the Bank of England is conscious of currency markets (the record decline in the Pound in 2008) when carrying out monetary policy. In addition, the BOE's proactive response to the credit crisis dwarfs the actions of the European Central Banks, which risks falling further behind the curve. In other words, investors began to question why they were pushing the Euro close to parity, when the economic fundamentals aren't much better in the EU than in the UK. Bloomberg News reports:

"The euro fundamentals are looking increasingly shaky," [said] a currency strategist. "It's clearer than ever the ECB has seriously misjudged the dire situation the region now finds itself in."

Read More: Pound Posts Record Weekly Gain Against Euro as BOE Cuts Rates

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Posted by Adam Kritzer | in British Pound, Central Banks, Euro | 1 Comment »

Reflections on the Euro

Jan. 12th 2009

The last two weeks have been eventful for the Euro: the common currency celebrated its 10th anniversary, Slovakia became the 16th member currency, and 2008 came to a volatile close. Analysts have taken advantage of this confluence of developments to publish a tide of opinion outlining its future. Supporters argue that the currency has forced member states to become fiscally responsible, as they can no longer print money to fund budget deficits. Moreover, the credit crisis proved the currency's raison d'etre; it has been an island of stability in a sea of volatility, with the currencies of some unlucky countries declining by 20% or more. Exchange rate volatility and interest rate divergence, which can cripple even robust economies in times of crisis, was nowhere to be found in the EU. As a result, Denmark, Iceland, and even the UK, could conceivably adopt the Euro in the not-too-distant future, especially since the latter's British Pound is closing in on parity.

Meanwhile, the Euro's detractors maintain that a one-size-fits-all economic and monetary policy is still not appropriate for a region as economically diverse as the EU. For example, while low interest rates may have been conducive to stable economic growth in Germany and France, they probably fomented real estate bubbles in Spain and Ireland, making the collapse even more painful in those locales than it had to be. Regardless, the consensus is that the Euro is here to stay, and will probably become an increasingly viable alternative to the Dollar. The Wall Street Journal reports:

The euro has climbed sharply again since Mr. Bernanke cut rates virtually to zero last month and signaled his new policy would be "quantitative easing" — i.e., printing as much money as it takes to revive the U.S. economy.

Read More: The Euro Decade and Its Lessons

Read More:

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Posted by Adam Kritzer | in Euro | No Comments »

UK, EU Rates Headed Downwards

Jan. 8th 2009

As investors gradually re-acquaint themselves with risk-taking, the interest rate story is once again dominating forex markets. For the last few weeks, this meant that investors were taking advantage of record-low US interest rates to fund carry trades in riskier currencies. Most recently, however, investors have begun to focus on the interest rate picture on the other side of the Atlantic. The Bank of UK just lowered rates to 1.5% and is "threatening" to match the Fed by dropping rates all the way to zero. The European Central Bank, meanwhile, is probably on the cusp of a similar interest rate cut. As commodity prices have relaxed and the credit crunch has slowed the expansion of the money  supply, the ECB is firmly justified in cutting rates, under the pretext of fulfilling its mandate, which is to guard against inflation. The upshot is that interest rate differentials, which have been fueling the Dollar's recent decline, may become less pronounced over the next year. Bloomberg News reports:

"There is increasingly more room for the ECB to be more aggressive on rate cuts. That will naturally put more pressure on the euro from an interest-rate differential perspective. We're seeing interest-rate differentials really come back into play in terms of a currency driver."

Read More: Euro Falls to Three-Week Low on Speculation ECB Will Cut Rates

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Posted by Adam Kritzer | in British Pound, Central Banks, Euro | No Comments »

Pound Versus the Euro

Jan. 7th 2009

In recent years, the idea of parity seemed to pop up repeatedly in forex markets. First, the Canadian Dollar breached the mythical 1:1 barrier against the USD; then, it looked as though the Australian Dollar would follow suit. The most recent battle for parity is being waged across the Atlantic Ocean, between the British Pound and the Euro. Both economic and monetary circumstances favor the Euro, as the housing crisis pummeled the UK economy and the UK Central Bank subsequently embarked on a steep program of monetary easing. The Euro has probably also received a boost from the perception that the EU is one of the most stable economies and investing locales, outside of the US. In any event, investors tend to get carried away with psychological milestones and ignore economic fundamentals, which means the Euro could quickly achieve parity, before pulling back. The Wall Street Journal reports:

On Monday, one euro briefly bought almost 98 pence, a new record. That paves the way for parity “as early as this week,” wrote Ashraf Laidi, chief market strategist at CMC Markets.

Read More: The Battle of Hastings, Revisited in Forex Markets

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Posted by Adam Kritzer | in British Pound, Euro | No Comments »

Central Banks Still Prefer Dollars

Dec. 18th 2008

Since its introduction only ten years ago, the Euro has ascended at an incredible pace. Perhaps the best proxy for its respectability is its growing share (currently estimated at 27%) of Central Banks' foreign exchange reserves. Still, most analysts reckon that the Dollar will remain ascendant for the near-term. For one thing, the perception remains that the US is the safest place to invest, and in fact this attitude has been reinforced by the current economic downturn. In addition, there is very limited doubt that the Dollar will be around for a very long time, whereas there are many skeptics who invariably insist that the Euro is on the verge of breaking up. In short, as the global economy rebalances itself, reserve accumulation will slow generally, and diversification into the Euro will slow specifically. Marketwatch reports:

In view of the value already tied up in holdings of U.S. government paper, it would take a decisive — and probably foolhardy — shift for the world's largest reserve holders in Asia or Latin America to transfer significant holdings of present reserves out of the dollar and into the euro.

Read More: Reserve shifts into the euro will slow

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Central Europe Continues to Chase Euro

Dec. 16th 2008

While the credit crisis has led some skeptics to presage the end of the European common currency, some in Central Europe are still eager to join it. However, their cause may have been jeopardized by the credit crisis. The economies of Poland, Hungary, and Czech Republic-the three most qualified candidates to join the Euro-have been plunged into turmoil. Capital flight has wrought precipitous declines in all of their respective currencies. In light of record volatility and continued bearish sentiment, some analysts have argued that the Euro represents the key to their salvation. The only problem is that the credit crisis is scrambling their ability to meet the necessary pre-requisites to membership. Bond yields trade at an unacceptable spread to those of Euro members, inflation has yet to be tamed, budgets have shifted from surplus to deficit, and reserves are shrinking faster than they can be replenished. And yet, there are those who remain optimistic. Bloomberg News reports:

"In Poland and Hungary the crisis has increased the public support for euro adoption and I'm keeping my bet that both countries will enter ERM-2 in the second half of 2009. The more euro-skeptic Czechs may do it a year later," said [one analyst]. 

Read More: Euro Dreams Fade for Zloty, Forint, Koruna on Slump

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EU Stimulus No Help to Euro

Nov. 27th 2008

The European Union has unveiled an economic stimulus package to match the US, as the two economies continue to mirror each other’s strategies for fighting the credit crisis. Given the evident lack of effectiveness of the US plan, it is no surprise that analysts reacted pessimistically to the policy proposal. At this point, investors and consumers alike appear resigned to the inevitability of economic recession in both economies. In other words, there isn’t much that government can achieve, as their respective efforts will certainly be undermined by increased saving. Besides, investors (including currency traders) remain focused on the financial aspects of the credit crisis, rather than the economic aspects. Accordingly, the theme of risk aversion continues to dominate, as part of a trend that favors the Dollar. Reuters reports:

Analysts said that the plan marked a step in the right direction, but uncertainty about its efficacy, and general concerns about a deep slowdown in the global economy were keeping investors in the mood to sell risky assets.

Read More: EU stimulus package raises concerns

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Euro: To Praise or Condemn?

Nov. 14th 2008

In light of the credit crisis, commentators on the Euro have taken to one of two extremes; either they believe the Euro is doomed, or they argue that the Euro represents the key to EU economic salvation. The naysayers point to recent trends in financial markets such as the widening spread between German and Italian bond yields. They further argue that a common monetary policy exacerbated the credit crisis by fomenting real estate booms in overheated economies, namely Ireland and Spain. Supporters, on the other hand, need to look no further than the complete economic collapse in Iceland to understand the advantages of the Euro. Moreover, some of the more fragile EU members (Luxembourg, Belgium) would have witnessed runs on their currencies, if not for their participation in the common currency. In the end, the Euro probably represents a viable investment alternative to the Dollar and it brings the benefit of relative stability to its members. While its supporters are prone to overstating its benefits, it’s not likely at risk of crumbling in the next few years. The Economist reports:

The euro’s defenders are convinced that the currency will still be there at the end of the crisis. That is a reasonable bet. But public support for the euro may still be painfully tested as economies deteriorate.

Read More: No room in the ark

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Pound and Yen Big Movers in Crisis

Oct. 15th 2008

Forex traders, and by extension, forex analysts, tend to focus on the Euro-Dollar currency pair because the two currencies are the most highly-traded and perceived as the most stable. As the financial crisis swirls with renewed vigor, however, the Pound and the Yen have been thrust into the spotlight, although for opposite reasons. The Pound has been Pounded (for lack of a better word) by dismal economic data emanating from the UK; investors remain pessimistic that the UK will recover since housing prices are tanking and the Central Bank has been slow to react. In the case of the Yen, the picture is more financial than economic. Japan’s economy and its capital markets have been pummeled by the credit crisis, but ironically, its currency is considered one of the safest. The reason is that investors have dramatically reduced their short-Yen positions which had been built up as part of carry trade strategy. Now, the name of the game is risk avoidance, which is good for the Yen but bad for the Pound. Seeking Alpha reports:

Out of the currency majors, USD/CHF and EUR/USD are the tamer pairs whereas GBP/USD and USD/JPY are pairs which are seeing the most volatile moves in forex trading, reflecting the strong bias of the underlying sentiment.

Read More: Amidst Chaos, Some Clarity on the Forex Markets

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Monetary Policy: US versus EU

Sep. 27th 2008

US political and economic officials are now operating in panic mode, as the credit crisis enters a new stage of direness. Politicians are hard at work trying to hammer out a bill that would funnel as much as $700 Billion into mortgage securities in a last-ditch effort to raise investor confidence. Ben Bernanke, Chairman of the Fed, has warned that failure to pass the bill could send the US economy into a prolonged recession and asset prices into a deflationary tailspin. Accordingly, the Fed may continue to act unilaterally if the US government can’t be persuaded to come on board.

Contrast this frenzy with the relative air of calm across the Atlantic: although the European Central Bank has toned down its hawkish rhetoric, its focus remains on inflation, instead than the state of the economy. Accordingly, a change in the current monetary environment (whether rate hikes or rate cuts) still seems somewhat unlikely. However, a moderation in inflation combined with an economic contraction could force them to re-think their strategy, especially if EU member states step up their rhetorical attacks. In short, as the Fed ponders yet another interest rate cut, it looks like the EU-US interest rate gap could conceivably widen before it narrows, reports the The Wall Street Journal:

Interest-rate futures suggest investors believe the Fed is likely to cut its key rate soon, perhaps even before its next meeting on Oct. 28 and 29.

Read More: ECB Leans Toward Keeping Rates Steady Despite Market Turmoil

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Bad News for the UK, EU

Sep. 11th 2008

The bad news is piling up in the US: Fannie Mae and Freddie Mac are in such dire shape that they will require the assistance of the US government merely to stay afloat. Meanwhile, Lehman Brothers, a large investment bank, is quickly crumbling a la Bear Stearns and could require a similar bailout. Fortunately for the US, the news across the Atlantic is just as bad, and getting worse. The median estimate for Eurozone GDP growth has been revised downward to an anemic 1.4% in 2008 and 1.2% in 2009. Analysts are speculating that the ECB will finally have to lower rates in order to prime the EU economy, and perhaps the Bank of UK will have to lower rates for a second time. It looks like this Dollar rally still has legs. Reuters reports:

Euro zone economic uncertainty was "particularly high," the European Central Bank president, Jean-Claude Trichet, said after the ECB left its interest rates at 4.25 percent on Thursday.

Read More: Dollar soars to highest level this year vs euro

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Decoupling Debunked

Aug. 28th 2008

When the credit crisis kicked off in 2007, many online forex traders and economic analysts quietly began to circulate the theory of "decoupling," which asserted the global economy was strong enough to weather a downturn in the US economy. In other words, it was expected that the credit crisis would be contained within the US, and the rest of the world would plod along, unaffected. This notion now appears to be completely without merit, except in a few isolated cases.

Instead, economies from Europe to Asia are sinking, and sinking fast. Some economies, namely Japan and Germany, have even begun to contract! Canada and Australia may slide into recession, regardless of what happens in commodity markets. Within this context, the Dollar’s 10% rally is not much of a mystery. In other words, this rally is probably more a function of economic weakness in other countries than of US economic strength. In addition, the end of de-coupling works both ways; a global economic downturn could further harm the US. A wave of negative economic data and/or the next round of debt write-downs could send the Dollar spiraling downwards. The Telegraph reports:

We are not witnessing a dollar rally so much as a collapse in European and commodity currencies. The race to the bottom has begun in earnest.

Read More: Dollar surge will not stop America feeling the effects of a global crunch

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Euro Hurt by Slowing Economy, Inflation

Aug. 26th 2008

The Euro has dropped almost 10% against the Dollar in a matter of mere weeks and everyone is wondering why. Setting aside the factors which favor the Dollar generally (irrespective of the Euro) because they were explored in previous posts, let’s instead examine those factors weighing specifically in the Euro. First, the recent decline in commodity prices is causing European inflation to abate. The Euro had previously derived significant support from the ECB’s hawkish stance towards fighting inflation. With lower prices, however, the need for further rate hikes may have evaporated. Second, the Euro-zone economy is looking increasingly fragile. Based on the most recent data, it actually contracted in the second quarter. Truth be told, the ECB hasn’t yet turned its attention from inflation to the economy, but if both prices and economic growth continue to slow, the Central Bank may be forced to loosen its monetary policy. In fact, the perceived inevitability of this fate may already be propelling traders to dump the Euro. Money and Markets reports:

While upping his concern for the euro economy, European Central Bank President Trichet has maintained his focus on rising prices. The latest predictions…however, point towards inflation having already peaked…

Read More: Dollar’s Rise Helps Level the Currency Playing Field 

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USD Reclaims Dominance

Aug. 15th 2008

The USD is officially trending upwards, having appreciated over 7% against the Euro in only a few weeks. Of course, hindsight is 20/20, and some analysts now claim that support for the Dollar had been building for several months. They point out that the first break for the Greenback came in March when the Fed stopped lowering interest rates. Then, at a meeting of the G8 nations, several high-ranking officials indicated that they were unhappy with the recent decline of the Dollar and suggested that coordinated intervention should be effected in order to prevent a further collapse of confidence. While this "verbal intervention" was ultimately not backed by any kind of substantive action, investors apparently took the hint.

Further comments by America’s Federal Reserve Bank and the Secretary of the Treasury made clear that the US remained committed to the Strong Dollar Policy. A reprieve in the rise of commodity prices, followed by the proposed bailout of the two cornerstones of American’s sprawling mortgage industry, convinced currency traders that the world’s economic policymakers simply would now allow the Dollar to fall further. Lo and behold, the Dollar failed to break through a resistance level at $1.60/Euro (near a record low), and has since rallied sharply. The International Business Times reports:

It seems that that the big money had committed to a long Dollar, and was waiting for the economic slowdown to spread to the Euro Zone. Once the Euro Zone began to experience a slowdown, it just became a matter of time before the short positions that had been built for several months would pay off.

Read More: U.S. Dollar Takes Control of Forex Markets

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Euro Needs Better Governance

Aug. 6th 2008

Last week, the Forex Blog covered an IMF report that claimed the period of Dollar hegemony is nowhere near finished. This view appears to be widely held, and an American economist argued in a recent op-ed piece that the Euro still trails the Dollar in terms of global prominence. Certainly, he acknowledged the collapse in confidence that has sent the Dollar spiraling downward over the last few years. Central Banks are holding an ever-increasing portion of their reserves in alternative currencies, namely Euros. Many new bond and stock issues are denominated in Euros. But ultimately, the Dollar is still Numero Uno.

However, the potential exists for the Euro can one day catch up the Dollar, such that the world’s financial system would rest on two equal pillars. The key, argues the aforementioned economist, lies in better governance. The European Monetary Union lacks coherent leadership, preventing it from projecting power outside the EU and increasing the role of the Euro in the global economy. In addition, the process by which EU economic and monetary policy is determined lacks transparency. The current structure encourages members to act selfishly, and there is tremendous disagreement and controversy surrounding even minute issues. Until this system is reformed, the Euro cannot seriously hope to compete with the Dollar.

Read More: Reforms that would help euro punch its weight

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ECB Hikes Rates

Jul. 3rd 2008

In a move that will shock some investors but please others, the European Central Bank has raised its benchmark interest rate by 25 basis points, to 4.25%. On several recent occasions, Jean-Claude Trichet had alluded to the possibility, in connection to soaring inflation. Critics, including several politicians, have countered that the ECB should also be cognizant of the macroeconomic picture in Europe, which is faltering amid the global credit crunch. But such naysayers should remember that the ECB is mandated to maintain price stability, rather than to explicitly facilitate economic growth. In any event, this move certainly throws a wrench into the forex markets. The Dollar had rallied over the last couple months, as traders had prepared for a narrowing US-EU interest rate differential in the medium-term. So much for that theory, reports The New York Times:

But the sharp rise in inflation has put Europe’s bank into a policy bind because it has been accompanied, in recent days, by evidence that the economy here is deteriorating much like that of the United States.

Read More: Eyes on Inflation, European Bank Raises Rate

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EU Inflation CounterBalances Oil

Jun. 23rd 2008

Forex analysts reckon the two most powerful forces weighing on the Dollar are commodity prices and European prices, so-to-speak. With regard to commodity prices, it seems plausible that rising commodity prices have contributed to a weaker Dollar, as much as vice versa. Thus, when Saudi Arabia announced recently that it would increase oil production, the Dollar received a nice boost. Conversely, European prices, or inflation, are important for traders to monitor because they represent a proxy for the future of EU monetary policy. Specifically, Eurozone inflation just touched another high, at 3.7%, which analysts point out is now 1.7% higher than the ECB’s stated comfort zone. The likely result is an interest hike in the near-term, which would further widen the differential with US interest rates. Unless, of course, the Fed follows suit with a rate hike if its own. Forbes reports:

"High oil and food prices are already clearly denting any hopes for a pick-up of private consumption but only a severe deterioration of economic confidence indicators might prevent the ECB from pulling the rate trigger at the next rate-setting meeting."

Read More: Euro climbs as inflation figures cement rate hike expectations

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Euro Aloof to Irish “No”

Jun. 17th 2008

Over the weekend, the people of Ireland resoundingly rejected the Lisbon Treaty, throwing up roadblock in the way of the most recent attempt to solidify the bond of the EU. Surprisingly, the Euro shrugged off the news and actually rose on the first day of trading following the release of the results. This marks a sharp departure from 3 years ago, when the rejection of a comparable treaty by the people of France and The Netherlands caused a panic in forex markets as analysts sounded the knell of the EU. The explanation for the diverging reactions is that the European Political Union has been de-coupled from the European Monetary Union. In this way, many Europeans may approve of the ECB and the Euro, while remaining skeptical about the loss of national political power at the hands of the EU. According to one expert, even if the political union were to completely dissolve, it is conceivable that the Euro would continue to exist, perhaps even flourish. The New York Times reports:

Certainly, political stalemate has not tarnished the euro so far. Since the rejection of the constitution by France and the Netherlands in 2005, the currency has risen 23 percent against the dollar, becoming an attractive alternative for bond traders and central bankers.

Read More: Despite Irish Vote, the Euro Remains Strong

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Euro Outshines Yen

Jun. 16th 2008

Most of the stories and analysis featured on the Forex Blog concern the Dollar, or at the very least, how other currencies are performing relative to the Dollar. But there are many important currency pairs that don’t involve the Greenback, including the Euro/Yen. Last week, the Euro climbed to its highest level in 2008 against the Yen, thanks to diverging economies and interest rates. Neither economy is particularly strong, but the Bank of Japan is using especially bearish language to describe its faltering economy. It should be noted that despite a prolonged period of economic growth, the Bank of Japan avoided raising interest rates even once. Meanwhile, the European Central Bank is becoming increasingly hawkish in its monetary policy rhetoric. The result has been a sustained (and soon-to-widen) interest rate differential, which has contributed to a dynamic that is unique to these two currencies. Bloomberg News reports:

The yen fell against every major counterpart today after a government report showed Japan’s longest postwar expansion may be over.

Read More: Euro Climbs to Year’s Highest Against Yen on Rate Speculation

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ECB, Unemployment Weigh on Dollar

Jun. 6th 2008

In the near future, this day may be looked back on as important in the battle between the Dollar and Euro that is currently being waged. The previous month had been relatively kind to the Dollar, which had gradually clawed its way back from a record low against the Euro. Then came yesterday, when Jean-Claude Trichet, leader of the European Central Bank, surprised investors when he announced that not only will the ECB not be cutting rates, but in fact, it may hike them. If enough members of the Central Bank become convinced that inflation is unlikely to abate, the rate hike could come as soon as next month. Today, the knockout punch was delivered, when the US unemployment rate came in at 5.5%. Not insignificant by itself, what was most shocking was that the crucial indicator had risen .5% from last month, its largest increase in more than a decade. Reuters reports:

That should undermine the dollar’s prospects…"The focus is on the unemployment rate, as it’s obviously starting to catch up with the softening in the payrolls figures…and that’s what the market is reacting to."

Read More: Dollar falls as US jobless rate shoots up

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A Chink in the Euro

Jun. 2nd 2008

The upcoming 10th Anniversary of the European Central Bank is being greeted with a flurry of commentary and analysis of its brief history. The consensus is that both the bank and the Euro currency over which it presides have come a long way. The respect that investors have come to accord the Euro with can be witnessed in its rapid appreciation over the last five years. The ECB has also been singled out for praise for its commitment to fighting inflation.

But the the fact that the overall Euro-zone economy is on solid footing masks some important disparities within.The economies of the so-called PIGS countries (Portugal, Italy, Greece, and Spain) for example, are faltering in the wake of the credit crisis, while their neighbor, Germany, notched strong quarterly growth of 1.5%. Some of the newest members of the EU are struggling, due in part to the Euro’s rise. This has led some commentators to return to the principal argument that initially opposed the Euro- that the economies of the Euro-zone were and continue to be too diverse, and that it does not make sense for them to be governed by a common monetary policy. Some of the original members, namely Italy, are openly disdainful of the perceived negative impact of the Euro on their respective economies. In fact, it is possible, though unlikely, that a protracted economic recession could lead some of them to abandon the Euro. The Times Online reports:

"The failure of eurozone governments to implement the necessary reforms during the recent good times may eventually sow the seeds of the break-up of the eurozone and the demise of the euro. Nothing lasts forever."

Read More: Reform failures may still kill off the euro

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EU Economy Weakens

May. 26th 2008

While the credit crisis has ravaged the economies of the US and the UK, the EU has largely been spared. First quarter GDP grew at a healthy annualized rate of 2.8%, helped by a whopping 6% expansion in Germany. However, a number of economic indicators now suggest that all is not well on the European front. Business and consumer confidence indexes are trending downward. Manufacturing output is down. So are retail sales. Spain, which benefited the most during the credit boom, is now reaping the greatest losses during the crunch, and could put a drag on the entire Euro-zone. One prominent economist is predicting that the EU economy won’t expand at all in the second quarter.

Unfortunately, the only data point which is trending upwards is inflation. Even though the EU is much more efficient than the US in terms of its use of oil, record oil prices (as well as food prices) are taking their toll. As a result, the European Central Bank cannot (or will not) lower interest rates until price inflation returns to a more palatable level. Accordingly, EU member states are taking matters into their own hands by unveiling economic stimulus plans and tax cuts. As far as the Euro concerned, the ECB’s focus on price stability (at the expense of growth) is not hurting the common currency, although if the economy really tanks, the story could change depending on concurrent circumstances in the US. The Economist reports:

The ECB has a strict remit to keep inflation in check, so rising commodity prices are likely to keep interest rates high, lending further support to the euro.

Read More: The euro-area economyToo good to last

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Chinese Exporters Dump Dollar

May. 8th 2008

The anecdotal evidence that China is diversifying its forex exposure away from the Dollar continues to mount. To date, most of the focus has centered around the Central Bank of China, which is passively diversifying its reserves into European and higher-risk assets. Apparently, Chinese exporters are also getting nervous about the impact of a falling Dollar on their respective bottom lines. The RMB has risen 11% since the beginning of 2007, which means Chinese companies now receive 11% less on sales to destinations abroad than they did for equal-priced goods in 2007. As a result, some companies have taken to quoting prices in Euros or to adjusting Dollar-denominated prices every few months. Other companies are building assumptions of a more valuable RMB into their profit models, and setting prices accordingly. The New York Times reports:

“We are gradually increasing our emphasis on the domestic market until we can forget about the export market, because the profit margins on exports are so thin,” [said one exporter].

Read More: Some Chinese Exporters Prefer Euros to Dollars

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April Marks Dollar Turnaround

Apr. 30th 2008

Earlier this week, the Forex Blog speculated that the tide was turning on the Euro, which  had retreated from the $1.60 threshold. Sure enough, the month of April saw the best monthly performance by the Dollar in over two years. The sudden about-face by the Dollar stems from changes in interest rate expectations. Only a couple weeks ago, the consensus among investors was that the Fed would cut rates further at its next meeting; the only point of uncertainty was whether rates would be cut by 25 or 50 basis points.

As of today, however, there is only a 25% chance that the Fed will cut rates at all, if you go by futures prices. Regarding the Euro, investors are no longer so sure that the ECB will hike rates in response to surging inflation. In short, the new consensus is that the US/EU interest rate differential has stabilized. Then there is the economic picture; investors have "chosen" to be pleasantly surprised by the most recent economic data. While the economic downturn still seems inevitable, it may not be as severe as investors had previously feared. Reuters reports:

In contrast to slightly stronger U.S. data, the Ifo German business sentiment index this week showed the biggest monthly fall since September 2001.

Read More: Dollar heads for best month in 2-1/2 years

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Forwards Gain Retail Appeal

Apr. 29th 2008

The anecdotal evidence for surging retail interest in forex is cropping up everywhere. Moreover, investors are no longer even limiting themselves to the spot market, utilizing derivatives to speculate on future exchange rates. In the UK, for example, 10% of investors intending to purchase real estate in the EU are utilizing forward agreements to hedge their exposure to the Euro, which has risen 10% against the Pound since the beginning of 2008. Evidently, prospective home buyers are hoping that the Euro returns to 2007 levels, which would significantly lower the cost of buying property there. However, if the Euro continues to appreciate, such investors could end up losing more than they bargained for. Homes Worldwide reports:

Even the movement in the markets over a couple of days can make the difference between owning a property and no longer being able to afford it.

Read More: Brits Gambling On Volatile Currency Markets

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Chinks in the Euro’s Armor

Apr. 28th 2008

2008 has witnessed a rapid appreciation in the Euro, which recently breached the psychologically important $1.60 barrier. Last week, however, the Dollar dramatically reversed course, leading many traders to speculate that the Euro’s best days may be temporarily behind it. There are two ideas underlying this theory. First, the Federal Reserve Bank is probably near the end of its tightening cycle, while the ECB has yet to begin. In addition, recent economic data suggests that the Euro-zone economy, which has appeared recession-proof in spite of the credit crisis, may soon falter. The best-case scenario, according to Dollar bulls, would be a loosening of monetary policy in the EU simultaneous with tightening in the US. If such a scenario were to obtain, it would bridge the interest rate differential between the two economies, which many believe is behind the weakness in the Dollar. The Wall Street Journal reports:

If bad news out of Europe starts to accumulate and the Fed stands pat, the dollar’s slide could taper off.

Read More: An Endgame for the Euro?

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G7 Warns of Volatility

Apr. 18th 2008

For the last few months, EU politicians have whined about the appreciating Euro.  Aside from some token comments by the European Central Bank, however, the world failed to pay heed.  That changed last week, when the G7 formally and harshly warned that volatility in forex markets risks harming the global economy. But talk is cheap, and the real question is whether it will be backed up by action. Most analysts reckon that it will be difficult and would take time for the governments of the EU, US, and Japan, at the very least, to put together a coordinated plan of intervention.  Besides, the window has probably closed on action by Central Banks, which have conducted monetary policy irrespective of currency valuations. Reuters reports:

The U.S. Federal Reserve Board [is] nearing the end of its interest rate-cutting cycle, the European Central Bank [is] likely to reduce rates before the end of the year, and things might not get much worse for the U.S. economy. That suggests the dollar may recover in the coming months, with or without official intervention.

Read More: G-7 leaders talk tough on currency markets

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Economists: Euro Correction Inevitable

Apr. 15th 2008

In a research note, two economists from Morgan Stanley predicted that the Euro will soon come crashing down, failing in its bid to rival the Dollar as a viable reserve currency. They observed that in the beginning of the decade, the Euro was viewed as joke from an economic standpoint. Since long-term economic fundamentals can’t reverse themselves in only a few years, they reasoned that the Euro’s rise must instead be a product of financial (capital flows) trends. Furthermore, as the EU becomes further integrated, a need will develop to diversify capital outside of the EU, thus reversing the trend of the last few years of diversification within the EU. The Globe and Mail reports:

The euro is overvalued because institutional investors…world have been diversifying out of their home markets at the same time as European investors have largely been diversifying within their home market.

Read More: The euro as reserve currency? Hah!

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ECB Holds Rates

Apr. 10th 2008

The European Central Bank (ECB) has decided to hold its benchmark interest rate at 4%.  Despite signs that the EU economy is slowing, inflation is hovering around 3.5%, and the ECB has announced that its priority will be to maintain price stability. Jean Claude Trichet, President of the ECB, declared during the accompanying news conference that he "deplores" volatility in the forex markets, an indication that he is concerned that the Euro is appreciating too rapidly.  It doesn’t help the Euro’s cause that the Bank of England lowered its benchmark lending rate to 5% earlier in the week and that the Fed is also in the process of easing monetary policy. Both the US Dollar and British Pound recently touched record lows against the Euro.

Read More: Trichet says deplores excessive forex volatility

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Euro Could Replace Dollar

Mar. 27th 2008

Two American economists recently conducted a computer simulation to determine how the role of the US Dollar as the world’s reserve currency will evolve over the next decade.  Their hypothesis- that the Dollar’s preeminence would be maintained- was contradicted by the simulation leading them to conclude that the Euro will overtake the Dollar within the next 10-15 years. This may be hard for many analysts to stomach, since the Dollar’s share in global currency reserves is 66%, compared to the Euro’s 25%. In addition, the Dollar has held its title for nearly 150 years, and it’s difficult to fathom its being replaced.

However, two factors have emerged within the last 10 years, lending support to the argument.  First, the US twin deficits have exploded; the current account deficit approximates $800 Billion and the national debt is estimated at $9.4 Trillion. Second, prior to the inception of the Euro, there didn’t exist a credible alternative to the Dollar. The Deutsch Mark and Japanese Yen initially seemed like potential candidates, but the German currency was folded into the Euro, and the Japanese economy has soured and taken over by deflation. Then there are peripheral factors, like US monetary policy, which is facilitating inflation and eroding the Dollar.  There are also signs that a neo-imperialist foreign policy has overstretched the US, and foreign Central Banks are becoming nervous.  The Financial Times reports:

Many developing countries will find it harder to maintain their dollar pegs. They may be reluctant to drop them now but there will come a point when the rise in inflationary pressures becomes unbearable.

Read More: This crisis could bring the euro centre-stage

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Bank Collapses, Dollar Plummets

Mar. 17th 2008

Over the weekend, Bear Stearns, a prestigious American investment bank, hurriedly scrambled to find a buyer in order to avoid having to file for bankruptcy. While a buyer (JP Morgan) was ultimately secured, investors remained jittery, as the collapse of this magnitude is virtually unprecedented.  When forex markets re-opened on Monday, the Dollar crashed against all of the world’s major currencies, namely the Euro and the Yen. Furthermore, analysts are now beginning to view forex intervention as increasingly likely. It’s still unclear whether the Bank of Japan or the European Central Bank (with or without support from the Fed) would spearhead any such intervention.  At the breakneck speed at which events are unfolding, however, no one will be surprised if a plan is quickly cobbled together. The Wall Street Journal reports:

"Were such intervention to be seen, (the euro) could briefly trade down to $1.55, yet unless the (ECB) is prepared to back up such intervention with a rate cut, intervention will be futile," said [one analyst].

Read More: Dollar’s Slide Keeps Pace

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Dollar Falls to Record Lows

Mar. 10th 2008

Over the last couple weeks, the Dollar has plummeted against all of the major currencies, falling below the $1.50 mark against the Euro for the first time ever.  It seems investors are reacting to a spate of negative economic data which are painting an increasingly bearish picture for the US economy.  In addition, the Fed seems likely to lower rates further while the ECB will maintain rates at current levels. For a brief period, talk of recession was actually helping the Dollar, as investors predicted that the global economy would be harmed more than the US economy, but it looks like that period has passed. As a result, the EU is growing increasingly alarmed, and the pressure is building for some kind of intervention.   AFX News Limited reports:

Euro group president Jean-Claude Juncker said currency markets are overreacting to the short-term outlook for the US economy. " We don’t like excessive volatility in exchange rates," Juncker said.

Read More: Euro group’s Juncker says currency markets reacting too hastily to US outlook

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Fed vs ECB

Mar. 7th 2008

Yesterday, the European Central Bank (ECB) maintained its benchmark lending rate at 4%.  Meanwhile, America’s Federal Reserve Bank has cut rates by 2.25% over the last six months.  For years, the ECB existed entirely in the shadow of the Fed and conducted monetary policy accordingly, but in this latest downturn, it seems to have broken free. The reason for the split can be found in the Central Banks’ different mandates: the Fed aims to promote growth, while the ECB is charged primarily with creating price stability. Thus, the ECB can easily avoid succumbing to analysts’ expectations that it will ultimately lower rates.  In addition, while EU politicians are pressuring the ECB to hold down the common currency, the ECB’s mandate is actually supported by the expensive Euro because it lowers the cost of imports. The New York Times reports:

Mr. Trichet has long held that central banks do their best work when their threats to raise interest rates deter inflationary actions in the first place, avoiding the need for excessive swings in the benchmark rate.  [He] called this concept “credible alertness.”

Read More: In Europe, Central Banking Is Different

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Dollar Notches Stellar Weekly Performance

Feb. 13th 2008

Last week, the USD recorded its best weekly performance since 2006, rising 3 cents against its chief rival, the Euro.  Apparently, analysts are becoming increasingly pessimistic about the effect of the America recession on the global economy.  The consensus is now that a dampened global economy will induce a trend towards risk aversion, which favors the world’s #1 and #2 reserve currencies, the Dollar and the Euro, respectively.  However, it also appears the near-term economic prospects for Europe are less rosy than originally forecast,.  Thus, if last week is any indication, the Dollar should receive a larger proportion of risk-averse capital. Reuters reports:

"Despite a torrent of bad economic news the dollar has been
on a tear this week, as the currency market recognized the fact that the slowdown in U.S. economic activity is likely to drag down growth in the rest of the G10 universe…"

Read More: Dollar set for biggest weekly rise since June 2006

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ECB Holds Interest Rates

Feb. 12th 2008

At its meeting last week, the European Central Bank (ECB) held its Euro-zone benchmark lending rate at 4.00%.  While the decision itself came as no surprise, analysts were nonetheless waiting with baited breath to hear what remarks would accompany it.  Jean Claude Trichet, the Bank’s President, eased up on hawkish comments he made the previous month, when he signaled that his primary concern was inflation rather than the risk of economic recession. This month, however, he changed his rhetoric markedly, indicating that the ECB was less willing to preempt rising price levels and would instead shift its focus to the possibility of a ‘sharp slowing’ of EU growth. Forbes reports:

Our view [is] that rate hikes are definitely off the agenda at this stage and by bringing a greater degree of uncertainty on the growth assessment, the ECB may be getting ready for a shift towards a more dovish policy language.

Read More: Euro sags after Trichet tones down hawkish stance

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ECB to Avoid Rate Cuts

Jan. 29th 2008

When America’s dot-com bubble collapsed in 2001, the Federal Reserve Bank moved quickly to quell the panic by slashing interest rates.  The European Central Bank (ECB), on the other hand, was adamant that it would not have to follow suit since the European and American economies were no longer so intertwined.  Several months later, it became increasingly clear that the ECB was wrong, and it was ultimately forced to lower rates.  Now, some analysts fear that history is repeating itself, as America’s housing crisis threatens to run a similar course as the collapse of the stock market bubble. The Fed has lowered interest rates twice in the last few months, while the ECB has yet to act, insisting that its primary concern is inflation. For now, the interest rate differential is supporting the Euro, but if the ECB falls behind the curve, a stagnating EU economy could bring down the common currency.  The New York Times reports:

But when it comes to the economy, Europe remains optimistic it can decouple itself and withstand collateral damage from a possible recession in the United States.

Read More: Why the European Bank Is Sitting Back

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Central Banks in the News

Jan. 14th 2008

As we wrote last week, the direction of the Dollar may be influenced more by external economic events rather than by internal activity.  Accordingly, it would behoove forex traders to direct their attention away from the Fed and towards the Bank of England and the European Central Bank, both of which face important monetary policy decisions later in the month. With regard to the Bank of England, futures markets have priced in a 2/3 chance that rates will be cut by 25 basis points. In the case of the ECB, the markets are expecting rates to be maintained at current levels. However, analysts will be scrutinizing the Banks’ respective press releases and monitoring other developments in this area due to the implications for the US-EU-Britain interest rate differential.  Reuters reports:

Some analysts think that hawkish comments from Trichet will be brushed aside with weaker economic data leading to the prospect of falling euro zone rates later in the year.

Read More: Pound down, others flat before ECB, BoE decisions

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ECB Mulls Rate Hike

Dec. 11th 2007

While holding rates steady at its meeting last week, the European Central Bank (ECB) raised the possibility of a rate hike at its next meeting, which is to be held on January 10.  Jean-Claude Trichet, President of the ECB, was especially forthright: "we will not hesitate to hike rates."  The Bank’s hawkish comments owe to a spate of recent economic data, which point to a strengthening Euro-zone economy.  At the same time, however, political pressure from certain EU member states is mounting for the ECB to rein in the Euro.  This notion is directly at odds with a rate hike, which would narrow the differential between EU and US interest rates, and provide further upward impetus for the Euro. Though, the pressure could subside since the EU economy is performing well, despite the strong Euro. DailyFX reports:

For those people who have been criticizing the Euro for hurting the Eurozone economy, their complaints continue to be refuted by economic evidence.

Read More: Euro Rallies on Strong Data and Hawkish Comments

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A reprieve for the Dollar?

Dec. 5th 2007

The last two years have witnessed a veritable collapse in the value of the Dollar, which has declined over 25% against the Euro, alone.  While opinion remains divided, many analysts are predicting a (temporary) cessation in the Dollar’s downward slide.  The reasoning is that the worst possible scenario involving the American housing crisis has already been priced into the Dollar.  Furthermore, experts argue that the inevitable loosening of American monetary policy will help boost the American economy by preventing it from slipping into recession. Finally, there is the notion that China will begin to take steps to appreciate its currency relative to the Euro, which has
actually risen against the RMB.  The law of triangular arbitrage requires that any rise in the Euro against the Yuan must be matched by a proportional rise in either the Dollar/Euro or the Dollar/RMB rate, the latter of which seems unlikely.  Dow Jones reports:

There is also the possibility that official Chinese purchases of the euro could decline after last week’s visit by a delegation from the European Central Bank to Beijing, anxious to reduce upward pressure on the single currency.

Read More: Chances Of Dollar Bounce May Be Rising

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EU Joins US in Calling for Yuan Revaluation

Dec. 1st 2007

In the campaign to pressure China into revaluing the Yuan, the US has by far been the loudest voice.  However, the rapid decline of the USD may have unintentionally earned the US a new ally in its fight: the EU.  Since the Chinese Yuan is essentially pegged to the USD, and the USD has declined against the Euro, the law of triangular arbitrage is such that the Euro has actually appreciated significantly against the Chinese Yuan.  EU officials are no longer standing by idly, since the exchange rate is beginning to deal serious harm to its balance of trade.  In fact, the EU now occupies third position on the list of countries with the largest trade deficits with China.  Because of the nature of China’s exchange rate regime, however, China’s ability to control the relationship of the Yuan with both the Euro and the USD will be difficult, if not impossible.  The Bangkok Post reports:

Given the fact that about 70% of China’s $1.4 trillion in foreign reserves are dollar-denominated assets and the majority of foreign trade transactions are cleared in US dollars, China has focused more on the RMB-dollar rate.

Read More: A tale of two currencies

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ECB Still Mulling Rate Hike

Nov. 13th 2007

At its last meeting, the European Central Bank (ECB) voted to maintain rates at current levels.  Nonetheless, inflation risks persist, and the ECB has not ruled out the possibility of hiking rates at its next meeting. At the same time, the Euro-zone economy is stalling, and the Bank has the onerous task of balancing these risks in trying to facilitate a "Goldilocks" economy. As a result, the ECB is in "information-gathering mode." Additionally, most of this information is publicly available economic data, and forex traders would be wise to do their own research, since the Euro-USD exchange rate outlook is tied closely to the monetary policy outlook. The Guardian Unlimited reports:

The ECB has said that slower growth in the 13-nation region would have an impact on its policy-relevant medium-term inflation outlook, and Gonzalez-Paramo said currency movements were one factor affecting growth.

Read More: ECB still in data-gathering mode

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ECB to Hold Rates

Nov. 8th 2007

The European Central Bank (ECB) will likely maintain its benchmark interest rate at 4.00% at its meeting his week.  The Bank of England is also expected to hold its lending rate in place, at 5.75%.  While these two moves should be seen by Dollar bulls as acts of clemency, they are more akin to a stay of execution than to a commutation of its death sentence.  The reasoning is that it is inevitable that the US-EU interest rate difference will be bridged over the next few months, as the Fed continues to lower rates while the ECB is in the process of hiking them.  The only question is when.  Accordingly, analysts will be paying close attention to the language employed by the heads of the various Central Banks at their next meetings to get a sense of timing.

Read More: Dollar hovers above lows

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Europe Asks China to Revalue Yuan

Oct. 10th 2007

Evidently frustrated by the Euro’s appreciation against the USD, a group of EU ministers has turned its attention to China, calling on it to allow the Yuan to appreciate against the Euro.  While the Yuan has appreciated nearly 10% against the USD over the last two years, it has actually decreased in value against the Euro.  As a result, the EU trade deficit has set a fresh record nearly every month. Unfortunately, the Yuan basically remains pegged to the USD, and since the USD is depreciating faster against the Euro than against the Chinese Yuan, the law of triangular arbitrage dictates the Euro must be appreciating against the Yuan.  It appears China’s hands are tied.  Bloomberg News reports:

“I can assure you China will continue to adopt a reform oriented policy on its exchange-rate mechanism,” said a Chinese Foreign Ministry spokesman. “But these
adjustments have to be done gradually and in line with the market.”

Read More: EU Calls on China to Let Yuan Appreciate Against Euro

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Euro sets another record

Sep. 20th 2007

Today, the Euro set another record, breaching the $1.40 mark.  While theoretically a meaningless achievement, $1.40 was an important psychological and technical barrier, since many traders place stop orders and limit orders at round numbers, such as $1.40.  Accordingly, upon surpassing $1.40, the Euro quickly accelerated upward, creating a short squeeze, where those who bet the Euro would not pass $1.40 were forced to buy to cover their positions. EU politicians have been surprisingly quiet as the Euro rose rapidly against the Dollar, commenting only that they would monitor the situation.  However, it seems inevitable that the value of the Euro will begin to play a more serious role in EU economic policy, since it is already beginning to hamper growth.  AFP News reports:

“Excessive volatility and disorderly movements in exchange rates is undesirable for economic growth,” European Central Bank president Jean-Claude Trichet said.

Read More: EU finance chiefs on guard over euro strength, market turmoil

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Trade data supports Yuan appreciation

Sep. 13th 2007

That the balance of trade between the US and China is becoming more and more lopsided in favor of China should come as no surprise to anyone.  In fact, economists yawned when the August trade data revealed a 33% jump in the Chinese trade surplus.  As a result, many are beginning to argue that China can allow the Yuan to appreciate at a faster pace against the Dollar, since it is obvious that China’s export sector will not be materially affected by a stronger Yuan.  In addition, China now exports more goods and services to the EU than to America, yet another statistic which supports the notion that China can allow its currency to appreciate against the Dollar (the implication here being that the Euro-Yuan exchange rate should be more important to China at this point).  Finally, China’s inflation rate is now hovering around 6.5%, its highest level in over a decade.  A more valuable Yuan would presumably make imports less expensive, thus lowering prices across the board for Chinese consumers. Bloomberg News reports:

The Chinese currency is selling for about 7.51 to the dollar. It has risen almost 6 percent against the U.S. currency in the past year while falling more than 3 percent against the euro, leaving the overall competitiveness of China’s exports little changed.

Read More: Rising Euro Is What China Needs to Dump Dollar

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Interest rate story buoys Euro

Sep. 11th 2007

The Euro is closing in on the record high it achieved against the Dollar in July.  Once again, it is the interest rate story which is driving the currency skyward.  The continued rise of the collective economies of the EU is coinciding with a decline in the American economy, spurred by falling prices in the real estate and capital markets. As a result, economists are forecasting that this month’s respective central bank meetings will bring about a rate hike in the EU and a lowering of rates in the US. This prediction, which is also supported by the prices of interest rate futures, would narrow the EU-US interest rate differential to just 75 basis points!  Bloomberg News reports:

Traders also added to wagers the euro will strengthen against the U.S. dollar, figures from the Washington-based Commodity Futures Trading Commission
showed on Sept. 7.

Read More: Euro Rises to Month-High Against Dollar on Growth, Rate Views

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US Job Slump Causes Dollar To Fall

Sep. 7th 2007

August reports show that the US lost 4000 jobs in one month. The biggest employment slump in several years, it appears that problems with the subprime market are affecting more people than ever. The dollar fell to a 30-day low after these reports went public. According to Reuters:

The euro vaulted to a one-month high of $1.3768 <EUR=> after the report before easing to $1.3751, up 0.5 percent. The dollar was down 0.8 percent at 114.42 yen <JPY=>, near a session low of 114.31 yen.

Read more: Dollar tumbles as August U.S. payrolls contract

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Dollar Holds Steady as World Awaits US Data Reports

Sep. 4th 2007

Credit problems in the US have been the source of much turmoil throughout the global markets in the past few months. Tuesday was good for the US dollar, which held strong against both the yen and the euro. However, forthcoming economic reports from the US may or may not tip the scales. According to Reuters:

"The panic is almost over, but the market has lost its direction and is waiting for more news, especially any good news," said Kikuko Takeda, a currency strategist at Bank of Tokyo-Mitsubishi UFJ.

Read more: Dollar drifts as U.S. data awaited for direction

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US Mortgage Troubles Now Affecting Euro

Aug. 14th 2007

The US subprime mortgage and credit sectors are in dire straits, which has investors around the globe scrambling to save their money. From Europe to Asia, everyone is experiencing shockwaves. Now, the euro can be counted amongst the Australian dollar and British pound sterling as an increasingly weakening currency. According to Reuters:

The euro hit a six-week low versus the dollar and a four-month low against the yen on Tuesday on a Spanish press report that Santander is facing $2.2 billion euro exposure to high-risk U.S. loans.

Read more: Euro falls as European exposure to US credit weighs

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Euro’s Rise due to Optimism?

Jul. 23rd 2007

The Euro’s rise against the USD over the last year has been swift and unimpeded.  Many commentators have theorized that it is intense pessimism surrounding the US economy and economic conditions-namely the burgeoning twin deficits-that is responsible for the Dollar’s demise.  Now, a new theory is being batted around, one that is quickly gaining traction with analysts:
perhaps it is optimism directed towards the EU economy rather than pessimism towards the US that is causing the Euro to spike.  After all, the European economy has rebounded nicely and boasts stable monetary and trade statistics. However, this notion of European optimism, if it in fact exists, has some analysts worried that the markets are becoming too optimistic, and that if they are not careful, they will end up wrecking the European economy by driving up the Euro too high. The Times Online reports:

If the euro keeps rising without limit, Europe’s export industries will be decimated, as they were not only in Britain, but also in America in the mid-1980s and also in Japan after 1995.

Read More: The euro’s rise and rise is unsustainable

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Norwegian Krone Rises on Rate Hike

Jul. 18th 2007

The Norwegian Krone is certainly not a very popular currency among participants in the forex markets.  Nonetheless, the currency has enjoyed a strong year, having moved away from clinging to the coattails of the Euro and has actually surpassed the common currency by a considerable margin.  In fact, the Krone recently touched a 10-month high against the Euro, and a multi-year high against the USD, spurred on by a rate increase by the Central Bank of Norway.  In addition, the consensus among analysts is that the Central Bank will hike rates several more times over the next year, bringing the benchmark rate to 5.75% by 2008.  Surely, the most opportunistic among us has already begun searching for a broker that facilitates trading in Krone!

Read More: Norwegian krone jumps as central bank hikes interest rates

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EU mulls currency “misalignment”

Jul. 17th 2007

With the Euro handily outperforming the USD, Japanese Yen and certain other major currencies, many EU leaders have begun lamenting the impact they foresee on the EU economy. As most amateur economists are doubtlessly aware, however, there is a tradeoff between control over one’s currency and control over one’s domestic economy. In other words, if the EU acted in concert to hold down the value of the Euro, the ability of the European Central Bank to conduct monetary policy would be severely constrained. Accordingly, Jean-Calude Trichet, President of the ECB, is insisting that any efforts directed towards holding down the Euro be political, rather than economic in nature. Surprisingly, he is not opposed to EU political leaders holding talks with their Japanese and possibly American counterparts to discuss the growing perceived “misalignment” between the Euro and the Dollar. The Financial Times reports:

Mr Trichet had made it very clear in his comments to the European Parliament last week that there should be a dialogue between European countries and their partners over currency matters.

Read More: View of the day: Currency Misalignment

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ECB, France at odds over Euro

Jul. 7th 2007

The political furor surrounding the soaring Euro is reaching fever pitch, as European politicians clash with central bankers over the role of the state in determining exchange rates. Jean-Claude Trichet, President of the European Central bank (“ECB”) has argued that the Euro should be valued strictly by the markets. Politicians from EU-member states, on the other hand, have frequently argued that the surging Euro is hampering economic growth and should be used as a tool in economic policy-making. The newly-elected president of France, Nicolas Sarkozy, has been a vocal critic of the ECB, arguing that the Euro should actively be held down. The Financial Times reports:

In contrast to the US and Japan, where the finance ministry sets the exchange rate regime and intervenes in exchange markets, eurozone central banks hold and manage foreign exchange reserves and have responsibility for any market intervention.

Read More: ECB takes aim at Sarkozy over euro

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ECB Defies Opposition and Hikes Rates

Jun. 7th 2007

The European Central Bank (ECB) today raised the benchmark European lending rate to 4%, its highest level in six years.  The move came amid fierce opposition by European politicians who rightfully fear that higher interest rates will only send the Euro higher against other industrialized currencies and crimp the European economy.  The Euro is hovering around record levels against the USD, Japanese Yen, and Chinese Yuan, even though its economy is probably the weakest of the bunch.  However, the nature of the European Union means the interests of all member countries need to be looked after; while many of the traditional European powerhouse economies are struggling, Eastern Europe, for example, is thriving.  Taking matters into his own hand, France’s new president, Nicolas Sarkozy, is threatening to legislate a forced decline in the Euro, and many analysts think he may succeed.  The Telegraph reports:

“Sarkozy and Prodi are not going to let go of this. There’s a groundswell of feeling that Europe is being taken for a ride by the rest of the world, and they’re not going to put up with it any more.”

Read More: ECB rates rise as gloves come off

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Carry Trade Beginning to Unwind

May. 1st 2007

Nearly two months ago, China’s stock market declined 15% in one session, leading capital markets around the world to drop off precipitously. This collapse quickly spread to forex markets, where spooked traders began to unwind their Japanese yen carry trades, fearful that the volatility would trigger a short squeeze, causing the Yen to rapidly appreciate. While the yen has returned to its former low levels, it seems foreign investors have prudently unwound up to 60% of their short positions in the Yen, anyway.

A quandary has plagued analysts, who are attributing the failure of the Yen to appreciate to a surge of carry trade interest by Japanese retail investors. Long term Japanese interest rates remain pathetically low, and Japanese investors have taken to buying securities in American and Australia, where yields are significantly higher. However, if Japan’s Central Bank begins to raise rates- as analysts expect will take place as soon as May- investors could be persuaded to repatriate their capital to Japan. The Economist reports:

Retail investors’ direct share of Japan’s
foreign-currency market may be 20-30%, whereas individuals’ holdings of foreign
currency exceed foreigners’ holdings of Japanese securities. The clue to the
yen’s future, in other words, lies with the little man.

Read More: Out with a whimper

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Euro hovers near all-time high

Apr. 30th 2007

The Euro is currently hovering above its all-time high against the USD, and is flirting with levels never-before-seen in the Euro’s brief, eight-year history.  The Euro had
toyed with the record for the last couple of weeks, before finally breaching it upon last Friday’s release of US GDP data, which indicated the US economy had weakened to its slowest pace of growth in over four years. Investors are now waiting to see how the Fed responds to this latest development, as the bank has found itself in the unenviable position of navigating rising inflation and a slowing economy. Reuters reports:

Benign inflation data and modest growth in Midwest business activity provided more evidence of slowing U.S. economic growth, keeping sentiment bearish for the dollar, traders said.

Read More: Dollar stays near record low vs euro in quiet


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Euro on Target to Break Through 2004 Record

Apr. 25th 2007

The Euro is quickly closing in on its all-time record against the USD.  The record exchange rate was clocked in December 2004, at $1.37 Euro/USD, but I suppose records exist for the sole purpose of being broken.  Besides, it was never really a question of if, but rather when the Euro would smash through the record.  If current trends continue, it looks like the when will be sooner rather than later, since the European economy appears to be entering a period of pronounced growth while the US economy has probably already peaked.

Analysts are now predicting that the European Central Bank will raise its benchmark lending rate by 25 basis points to 4% at its June meeting, which should give the Euro a further boost.

Read More: Euro nears record high against dollar

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ECB cautions against Euro appreciation

Apr. 23rd 2007

“Pick your battles,” seems to be the mantra that Jean-Claude Trichet, President of the European Central Bank (“ECB”), is currently living by.  While the Euro is slowly inching closer to record levels against the USD, Trichet has largely been content to focus his energy on a different nagging currency: the Japanese Yen.  Trichet has invoked the phrase “two-way risks” in cautioning investors to beware the enormous potential upside of the Yen.  Trichet realizes that the Japan-EU interest rate differential, manifested through the carry trade, is responsible for the diverging Euro-Yen exchange rate.  Ultimately, it remains unclear whether the EU will continue to limit itself to rhetoric in the battle to hold down the Euro, or whether it will use more heavy-handed tactics.  Forbes reports:

“We believe the Japanese economy is on a sustainable path and that foreign exchange rates should reflect that,” Trichet said.

Read More: ECB’s Trichet says currency markets should be
aware of ‘two-way risks’

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EU Leaders to Discuss Euro Appreciation

Apr. 20th 2007

As the Euro has gradually risen over the last year, EU leaders have been conspicuously silent.  Sure, generic comments had been made lamenting “volatility” in the forex markets.  But few politicians had made overt declarations that Euro’s appreciation was a matter that merited attention from EU member governments. This week, the silence was broken, as two notable politicians, the Prime Minister of Luxembourg and the Finance Minister of France, commented on the Euros’ appreciation, going so far as to discourage market participants from coaxing the Euro upward. IOL News reports:

“The markets should not embark on one-way bets.” Asked about the apparently resigned attitude of European countries…on exchange rates, Juncker [Luxembourg’s PM] hinted that there was more attention paid to the euro’s strength than reflected in the final statement.

Read More: EU finance chiefs to focus on surge of euro

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Euro reaches two-year high against USD

Apr. 5th 2007

The demise of the USD continues, as the Euro rolls in the opposite direction, touching a two-year high against its American counterpart currency.  Analysts attribute the Euro’s sudden resurgence to the opposite directions that EU and US monetary policy appear to be headed.  In America, the question is no longer if rates will be lowered, but rather when they will be lowered.  Meanwhile, as Europe’s economy expands on the heels of export growth and strong industrial activity,
prices are rising and the European Central Bank is talking about raising rates. Bloomberg News reports:

ECB President Jean-Claude Trichet said he wants to ensure price stability in the euro region. Interest-rate futures contracts show the ECB is likely to raise borrowing costs by a quarter-percentage point by September while the Fed makes cuts.

Read More: Euro Jumps to Two-Year
High Versus Dollar on ECB Rate Outlook

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ECB signals rate hike

Feb. 14th 2007

At its monthly meeting to determine the region’s monetary policy, the European Central Bank decided to leave rates unchanged at 3.5%, but signaled that it would likely hike rates next month. The Bank’s president, Jean-Claude Trichet, who is an advocate of transparency, used his trademark phrase of “strong vigilance” to convey the Bank’s intentions to financial markets. The move will propel European rates ever closer to US rates, narrowing the differential which many believe is the only thing standing in the way of a long-term USD decline. However, European political pressure will likely prevent rates from being raised too high, as politicians fear an expensive Euro is hampering the EU economic recovery. The Financial Times reports:

Mr Trichet, who stressed the ECB’s independence, expected inflation to rise again this year and said that “the decisions we take today are to ensure price stability later on”.

Read More: ECB signals rate increase in March

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ECB rate decision to drive Euro

Feb. 8th 2007

The European Central Bank (ECB) is scheduled to meet tomorrow to mull the region’s monetary policy. With the Euo/USD exchange rate relatively unchanged over the last couple months, investors will be closely eying the ECB for signals about the direction of European interest rates over the coming months. The consensus is that the Bank will leave rates unchanged at the current meeting, but commentators have been quick to point out that inflation is slowly inching up, which could precipitate future hikes. Either way, Jean Claude Trichet, the notoriously transparent president of the Central Bank, will likely give investors a very clear picture of where he expects European interest rates will move in the near-term. DailyFX reports:

CB President Jean-Claude has been eager in the past to correctly steer market expectations, so if there is a chance of further hikes beyond March, the central bank will not want markets to totally dismiss the possibility of further moves.

Read More: Euro Price Action Contingent on ECB Decision, Commentary by Trichet

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ECB rate decision to drive Euro

Feb. 8th 2007

The European Central Bank (ECB) is scheduled to meet tomorrow to mull the region’s monetary policy. With the Euo/USD exchange rate relatively unchanged over the last couple months, investors will be closely eying the ECB for signals about the direction of European interest rates over the coming months. The consensus is that the Bank will leave rates unchanged at the current meeting, but commentators have been quick to point out that inflation is slowly inching up, which could precipitate future hikes. Either way, Jean Claude Trichet, the notoriously transparent president of the Central Bank, will likely give investors a very clear picture of where he expects European interest rates will move in the near-term. DailyFX reports:

CB President Jean-Claude has been eager in the past to correctly steer market expectations, so if there is a chance of further hikes beyond March, the central bank will not want markets to totally dismiss the possibility of further moves.

Read More: Euro Price Action Contingent on ECB Decision, Commentary by Trichet

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Commentary: USD on its last legs

Feb. 5th 2007

The USD has begun 2007 in neutral, idling against most of the world’s currencies, even gaining a few PIPS. However, this current period most likely represents a respite-rather than a reversal-from the USD’s long-term downward trend. The fundamentals behind the USD haven’t changed; if anything, they have worsened. Meanwhile, as the price of oil sinks back to sustainable levels and Central Banks move to diversify their reserves, governmental demand for USD-denominated assets may begin to stall.

The British Pound and Euro represent suitable alternatives to the USD. Both are strong currencies backed by political and monetary stability, as well as strengthening economies and rising interest rates. Risk-averse investors can already earn comparable returns from the side of the Atlantic opposite the US. In addition, as European capital markets expand and develop, foreign investors are discovering new assets to scoop up. Private equity and other forms of alternative investing are booming in Britain and the EU, which means even investors in search of risk have options in Europe.

Moreover, Asia and the Middle East are in early stages of developing regional currencies, which would also pose a threat to the dominance of the USD as the world’s reserve currency. As the global economy becomes more stable and as European and Asian capital markets surpass their American counterparts in size and clout, investors will no longer feel compelled to pool their wealth in American securities.

As former Treasury Secretary Robert Rubin recently noted, the only thing that is propping up the USD is that the demand for US assets (i.e. stocks and bonds) still exceeds supply. However, as equity prices approach levels never before seen and as the supply of bonds either dries up or yields are driven down to completely unattractive levels, the US will certainly lose its appeal to foreign investors and the USD will follow the foreign demand for US assets downward.

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Relative EU exchange rates diverge

Jan. 29th 2007

One technique for estimating the relative value of the Euro is to aggregate the value of all of the constituent EU currencies, using relative price movements as proxies for currencies. In Spain and Italy, for example, wages have skyrocketed over the past five years while productivity has lagged, which means these countries are relatively more expensive now. Germany, on the other hand, has been the economic leader of the EU, having benefited from declining real wages and surging productivity. When viewed as a sum of its parts rather than as a whole, Europe is plagued by many of the same economic problems that beset America, such as a negative balance of trade. A weighted average of European prices reveals a picture of what the Euro should be worth. Based on these three countries, it looks like the Euro is between fairly valued and overvalued. The Economist reports:

Spain now has the second-largest current-account deficit in the world in dollar terms. Germany’s resurgence has set a challenge for the euro zone’s southern members. Without the option of devaluation, their medium-term outlook looks less than rosy.

Read More: Beggar thy neighbor

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Euro displaces Dollar in global capital markets

Jan. 17th 2007

That the USD has remained the world’s de facto reserve currency has surely prevented the currency from declining significantly at a time when economic fundamentals seem to warrant it. However, the USD is slowly losing its luster as many of the world’s central banks have formally announced plans to diversify their foreign exchange holdings by holding more assets denominated in assets. As if that weren’t enough, a tally of global bond issues revealed that for the second consecutive year, more bonds were denominated in Euros than in USD. In addition, US stock exchanges accounted for just 15% of global equity offerings, down from 60% in 2000. The implications for foreign exchange markets are ominous: the role of the USD in global capital markets is diminishing, which is bad news for USD bulls. The Financial Times reports:

As recently as 2002, outstanding euro-denominated issuance represented just 27 per cent of the global pie, compared with 51 per cent for the dollar.

Read More: Euro displaces dollar in bond markets

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ECB nervous over Euro appreciation

Dec. 15th 2006

Jean Claude Trichet, president of the European Central Bank, is know for his terse, deliberately vague commentary. This week, he veered slightly away from that modus operandi by speaking out against Euro “volatility” in forex markets. In other words, he has not been delighted by the Euro’s rapid appreciation against the USD. While Trichet indicated that such an appreciation is bad for EU growth, he did not encourage EU governments to attempt to stabilize the currency. Thus, it is not clear how the markets will react to such comments, although if it appears likely that the ECB will alter its monetary policy as a result of the Euro volatility, the markets will certainly take notice. The International Herald Tribune reports:

ECB President Jean Claude Trichet said that while globalization had led to lower import costs for manufactured goods, it had boosted demand and increased oil prices.

Read More: ECB president says volatility in currency markets not good for long-term growth

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ECB raises interest rates

Dec. 7th 2006

The woes of the USD continued today, as the European Central Bank (ECB) raised its benchmark interest rate by 25 basis points, to 3.5%. The move was widely anticipated by economists, who predict two additional rate hikes in the spring will bring the ECB closer to the end of its tightening cycle and leave rates at 4%. Jean-Claude Trichet, president of the Central Bank, used GDP growth to justify the rate hikes and pointed to data that indicate the EU economy will grow by 2.9% this year, and by as much as 2.7% next year. While inflation does not loom as large as it did over the summer, the ECB is still clearly vigilant, which should be a cause of concern for Dollar bulls. Marketwatch reports:

Read More: European Central Bank lifts rates…

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Euro to include more countries

Nov. 28th 2006

The Euro common currency seems keen on inviting more countries to join. The only problem is that the EU has established prerequisites for membership that even current members would find difficult to satisfy. These terms are framed around stability, especially with regard to price, currency, the economy, and the budget. Slovenia and Estonia have satisfied the economic and currency requirements but are experiencing difficulty in managing their respective budget deficits and controlling inflation. Meanwhile, other countries, such as Sweden and Belgium, which are eligible for Euro membership, are having trouble garnering public support for the common currency. In short, it could be five years or more before the Euro expands to include more members. The Economist reports:

Westerners are starting to feel uncertain too. The Euro zone may already have too many misfits (Italy, for example, or Greece).

Read More: An Uncommon Current

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French President dampens Euro

Nov. 14th 2006

Why is it that every political leader thinks his nation’s currency is undervalued? South Korea, China, and Japan all actively engage in some form of currency manipulation. American politicians argue that the USD needs to depreciate in order to prevent the burgeoning trade deficit. Most recently, the president of France jumped on the bandwagon of forex intervention, arguing that Europe needed to take steps to hold down the value of its currency. He went so far as to challenge European political leaders to fight the efforts of the ECB to tighten monetary policy, which he sees as partially responsible for the Euro’s recent strength. However, opinions were mixed as to whether the Euro will suffer. The Financial Times reports:

[One analyst] was surprised at the zeal of the currency market’s reaction, given that there was little Mr Villepin could do about the strength of the euro other than lobby the ECB.

Read More: French PM sparks fall in euro

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China pushes reserve diversification

Nov. 13th 2006

Every month, almost like clockwork, when China announces its new total of foreign exchange reserves, a cloud of paranoia descends on currency markets, as traders weigh the likelihood of China diversifying its reserves. This month was different, however, as this paranoia seems to have been born out by Zhou XiaoChuan, chairman of China’s Central Bank. He stated explicitly that China would *continue* to diversify its reserves, but did not specify particular currencies or investments that would be targeted. However, the consensus is that any diversification by China, regardless of the scope, would surely benefit the Euro.

“Plainly, there’s a lot of sensitivity on this issue, and as an investor, one has to respect the market’s reaction.”

Read More: China’s reserve plans keep forex market on edge

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ECB promises “strong vigilance”

Nov. 2nd 2006

At its monthly meeting held his week, the European Central Bank (ECB) left the benchmark Euro-zone lending rate unchanged at 3.25%. However, Jean-Claude Trichet, president of the ECB, announced that the ECB would exercise “strong vigilance” in monitoring economic conditions and weighing future rate hikes. While this kind of language could be confused as rather vague and generic, Trichet’s promise of “vigilance” has been used in the past to preface rate hikes. In addition, Trichet hinted that he would conform to the markets’ prediction that the ECB will raise rates in December. Meanwhile, the US economy is sputtering, and many economists expect the Fed to lower interest rates by a notch in the coming months, which could provide the impetus for the inevitable appreciation of the Euro. The Financial Times reports:

“We have a sneaking suspicion from the tone of the minutes that the ECB feels that it may well have at least a little more work to do in 2007 after December’s interest rate hike.”

Read More: ECB statement boosts the euro

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Pound and Euro move in lockstep

Oct. 23rd 2006

In recent years, the British Pound and the Euro have begun to converge in value, so much so that both currencies have traded within 5% of each other for almost a year now. There are a couple of explanations for this trend. First, the relationship between the Pound and the Euro are largely symbolic. Perhaps, investors are grouping the two currencies together because of some perceived economic and/or political similarities. Second, it seems that all of the currencies that are supported by any semblance of sound economic fundamentals have risen against the USD, so it is possible that the Pound-Euro convergence is simply the result of both currencies simultaneously appreciating against the USD. Monetary policy and economic cycles are not aligned in Europe and Britain, so it doesn’t seem this link has any strong fundamental basis. Whatever the reason, in all aspects except for in name, the Pound has officially been absorbed into the Euro. The Financial Times reports:

From the euro’s launch in January 1999 until 2003, the pound initially traded in a wide 21.1 per cent range against the euro. Since then, volatility has been significantly reduced with the trading range falling to 8.6 per cent in 2004 and 7.1 in 2005.

Read More: Sterling in accord with the euro

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How does public debt affect currencies?

Oct. 19th 2006

By now, we all know that in the short run, interest rates and currency valuations are often correlated. In the long term, however, interest rate parity dictates that a country’s currency should move in the opposite direction as its domestic interest rates, in order to guarantee that investors in different countries receive comparable returns. This is consistent with financial economics, in that higher-yielding securities tend to elicit less demand, which means that the corresponding currencies sag due to insufficient capital inflows. Now, let’s apply this theory to the recent downgrade of Italy’s public debt. This downgrade will drive Italian interest rates higher as risk-averse investors flee Italy in search of safer investments. (Bond prices and interest rates move in opposite directions) The resulting capital outflows would cause the Italian currency (if it still existed) to depreciate. Fortunately for Italy, the capital outflows it suffers will be spread across the entire Euro-zone, and the net effect on the Euro will be negligible.

Read More: Euro shrugs off Italy downgrades

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EU economy shows signs of life

Oct. 11th 2006

When Jean-Claude Trichet, president of the European Central Bank (ECB), threatened “vigilance” against inflation last month, markets braced for what they believed would be several consecutive rate hikes. Recently, however, inflation seems to have largely disappeared, thanks to a leveling off of commodity prices. In the eyes of Euro bulls, this trend has been offset by a spate of positive economic indicators, which suggest the EU economy is as strong as it has been in over five years. Economists are now projecting growth of 2.5% for the EU area this year, with productivity increasing and unemployment declining. The result should be higher interest rates and a proportionately stronger Euro. The Economist reports:

In the long run, theory suggests that higher growth, other things equal, should mean higher interest rates for a given rate of inflation.

Read More: The euro area’s economy

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ECB lowers rate hike expectations

Sep. 26th 2006

Since reaching a one-year high over the summer, the Euro has been punished in forex markets, due primarily to a less favorable outlook for ECB rate hikes. Previously, analysts were expecting the ECB to raise rates three to four more times, raising the base rate to 4%. Now, however, analysts have revised their models to reflect one to two rate hikes. Forecasts for the Euro have been adjusted proportionately to undo the narrowing of interest rate differentials that Euro appreciation had been predicated on. The Daily News reports:

Steve Pearson at HBOS said the scaling back in rate hike predictions is probably a reaction to the drop in oil prices which should in turn drag euro zone inflation well below the European Central Bank’s 2 pct target rate.

Read More: Euro continues lower as investors rethink ECB rate hike prospects

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ECB rate hikes appear uncertain

Sep. 1st 2006

Speculation has been building in forex markets over whether the European Central Bank (ECB) will raise interest rates at this week’s meeting. Previously, the consensus among traders was that the ECB would continue to tighten through the end of this year in order to keep pace with inflation. Since then, however, new data has been released, indicating that the European economies may have already peaked. Germany’s economy, for example, is now predicted to expand by less than 2% this year. Combined with moderating inflation, these new numbers indicate that another rate hike may not yet be needed. As a result, the narrowing interest rate differentials that USD bulls were fearing will not likely be realized for a few more months. Dow Jones News reports:

“There has been little indication that the central bank is prepared to step up the pace of its interest rate hikes and the likely timing for the next move is the meeting Oct. 5, with a further one in December leaving interest rates at 3.5% by year-end.”

Read More: ECB Unlikely To Hold Surprises For Euro

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ECB to further tighten money supply

Aug. 10th 2006

Last week, the European Central Bank raised interest rates to 3%. This move had been telegraphed to investors over the preceding few weeks, and the markets hardly stirred when the rate hike became official. Investors are much less certain about what the future will bring, but the consensus is the ECB will continue to hike rates. Growth is slowly picking up, and decreasing unemployment is removing slack from the labor markets. Meanwhile, Europe’s inflation rate, the indicator which the ECB openly uses a basis for conducting monetary policy, is hovering around 2.5%, which means the bank could certainly stand to raise rates further, to the tune of 50 or 100 basis points. Unfortunately for USD bulls, the ECB is beginning to tighten just as the Fed nears a peak in its interest rate cycle, which will make investing in the EU a more attractive option. The Economist reports:

The ECB has said for a while that the euro area’s recovery is becoming more broadly based, shifting from exports towards domestic demand. If the American economy is slowing sharply, that is just as well.

Read More: Monetary policy in the euro area

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Interest rates rise in Europe

Aug. 3rd 2006

The two most important Central Banks in Europe independently raised interest rates today. The European Central Bank (ECB) was first to announce a rate hike, in a move that was widely predicted by investors. The Central Bank of UK, however, caught most investors completely off guard when it announced a rate hike of its own. It appears to be a coincidence that both banks raised rates on the same day, as the economic policies of the UK and of Europe are not entirely related. The news made USD bulls nervous on two fronts: first, the narrowing of interest rate differentials means it is more attractive to move capital to Europe. Second, and less obvious, is the implication that growth is picking up in Europe, at the very moment it is slowing down in the US. The Financial Times reports:

Jean-Claude Trichet, ECB president… said that if the eurozone economy performed as the bank expected, “a progressive withdrawal of monetary accommodation will be warranted”.

Read More: ECB and UK join drive to raise rates

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US Asset Inflows Weaken in April

Jun. 15th 2006

A report released today showed that US portfolio inflows dropped sharply in April and were not enough to cover the trade deficit. This led to a decline in the USD’s value agains the euro. The euro briefly hit its session high of $1.2658 before settling at $1.2615, up 0.1% from yesterday, at 1:00pm. According to Forbes:

“To the extent the private sector suddenly decided they didn’t want U.S. securities that meant there were more dollars available on the foreign exchange market and that meant downward pressure on the dollar,” Chris Probyn, chief economist with State Street Global Advisors in Boston, said.

Read more: Dollar slips vs euro on weak April US asset inflows

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Dollar Continues Advance Near 5-Week High Versus Euro

Jun. 13th 2006

As investors expect another rate hike by the Fed later this month, the US dollar came close to hitting its five-week high against the euro today. The Labor Department reported that US monthly wholesale prices were up 0.2% in May while the Commerce Department reported that retail sales rose by 0.1% in May. All of this has been in line with forecasts, thereby furthering the prediction that the Fed will raise interest rates soon. Forbes reports:

The upward shift in US interest rate expectations has helped the dollar, as has the general volatility engendered by this spike up. What has been bad for equities and commodities has benefited bonds and the dollar as they are considered to be less risky assets.

Read more: Dollar near 5-week euro highs on Fed rate hike expectations

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USD Near One-Year Low Versus Euro

Jun. 5th 2006

The US Dollar dropped to $0.7704 against the Euro earlier today, the lowest level since May 2005, before climbing back up to $0.7722 during midday trading in New York. The USD drop came after low U.S. employment data was released last week, thereby lowering expectations that the Fed would raise interest rates this month. Reuters reports:

Reflecting market expectations that the dollar’s interest rate advantage is set to erode, currency speculators have increased their bets that the euro will appreciate against the dollar to record highs, data showed on Friday. “If you look at market positioning you can see that dollar bearish sentiment is pretty much growing across the board,” said Naomi Fink, foreign exchange strategist at BNP Paribas in New York.

Read more: Dollar near 1-year low vs euro as key cenbanks eyed

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Ifo Data Stronger than Expected

May. 24th 2006

The latest Ifo survey released earlier today showed only a slight dip in German business expectations. The index dropped from its 15-year high 105.9 in April to 105.6 in May, much better than most had expected. While the Ifo may slip more in the coming months, a sharp dropoff is unlikely, as most believe the German economy should gain momentum later in the year. Forbes reports:

‘The smaller than expected drop in the index will help the euro to sustain its gains and will do little to dissuade many in the market who look for the ECB to hike by 50 basis points next month,’ said Mitul Kotecha.

Read more: Euro remains firm after strong Ifo data; market awaits US data

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Euro Gains Support from OECD

May. 23rd 2006

Despite expectations of an interest rate hike by the ECB next month, the euro gained support as the OECD was only moderate in its calls for interest rate rises in the Eurozone. They said that the hikes should only be gradual and its chief economist Jean-Philippe Cotis said that the ECB should wait for second quarter GDP data before increasing rates further. The euro also gained support from Germany’s deputy finance minister Thomas Mirow when he indicated that the German economy was unaffected by the euro’s high level. Investors are currently awaiting tomorrow’s release of the Ifo survey on German business expectations. It is expected that it may show only a slight dip despite the euro’s high level.

Read more: Forex – Euro remains well-supported; market awaits German Ifo data tomorrow

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ECB drives Euro to one-year high

May. 5th 2006

The European Central Bank deserves full credit for the Euro’s breakthrough to a one-year high against the USD, yet it didn’t lift a finger. Rather, the ECB all but assured investors it would raise interest rates by 25 basis points to 2.75% in June. Jean-Claude Trichet, President of the ECB, joked with investors that they have been able to predict European monetary policy with reasonable accuracy. Trichet also commented the EU’s economic recovery, which is driving inflation and necessitating the interest rate hike. Reuters reports:

The [Euro] has climbed over 3 percent against the dollar in the past month to its highest level in almost a year and to a similar comparative level on a trade-weighted basis.

Read More: ECB steps up inflation warnings, signals June

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USD plummets against Euro

Apr. 25th 2006

Last year, the strength of the USD against the Euro came as a great surprise to currency traders and economists, alike, who believed it was only a matter f time before fundamental factors caught up with the dollar. In the last few months, however, the Euro has steadily climbed against the USD, all without much fanfare. This week, it crossed a psychological barrier and reached the milestone of 7-month high. The currency has been buoyed by strong economic indicators, notably German business confidence data. Marketwatch reports:

“The euro strengthened across the board as strong data and official comments contributed to expectations the ECB could ramp up its tightening path.”

Read More: Dollar low vs. euro, steadies on yen

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Forex diversification talk buoys Euro

Apr. 24th 2006

As the EU economies gather momentum, the belief that the European Central Bank will tighten monetary policy to head off inflation is gaining widespread acceptance. And with it, talk of forex reserve diversification is spreading. Several OPEC countries have already announced they will begin to invest oil profits in Euro-denominated securities. Further, in a display of European solidarity, Sweden will adjust the composition of its reserves so that European assets represent a majority. Finally, Russia will soon begin rotating a portion of its $61 Billion oil fund into European bonds. AME Info reports:

With the breakdown of the EU Constitution well behind us, the market has feels that reserve diversification is a theme that is here to stay.

Read More: More Central Banks Talk of Diversifying to Euro

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Euro breaks out of trading range

Apr. 14th 2006

For months, Euro bulls have used fundamental economic analysis to support their claim that the Euro was due to appreciate against the USD. They have since been joined by many technical analysts, who jumped on the Euro bandwagon after the Euro seemingly broke out of a tight range that it had been confined to for months. Forex markets have also begun to take note, using even insignificant economic indicators as a basis for Euro support. The USD, in contrast, has shown scant signs of life, despite improved prognoses for American monetary policy and a stabilizing trade imbalance. Dow Jones News reports:

The widely expected dollar demise slated for in the latter part of the year may be upon us, as the euro rallies to more than a two-month high versus the greenback and flirts with levels close to the year high.

Read More: Euro Strength Vs Dollar May Be Here To Stay

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ECB may hike rates in June

Apr. 12th 2006

According to a senior member of the European Central Bank (ECB), the bank may raise interest rates at its next meeting, which is currently scheduled for June. As you may recall, there was a frenzy of speculation that surrounded the Bank’s last meeting, as many analysts had expected a rate hike. According to the official, however, the ECB merely wants to wait and confirm that actual growth and inflation figures accord with expectations. In short, it seems the ECB is in the process of tightening its monetary policy, but the pace may be a little slower than usual. Bloomberg News reports:

With the Federal Reserve also tightening credit and the Bank of Japan likely to do so before the end of 2006, the world economy faces the first round of synchronized rate increases in six years.

Read More: ECB’s Liebscher Signals June Rate Increase as Economy Picks Up

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ECB: no rate hike in May

Apr. 6th 2006

In the days and weeks leading up today’s meeting of the European Central Bank (ECB), the Euro had begun to gather steam as traders and analysts braced for the bank to signal a rate hike in May. Such a move would be a step towards reducing the differential between European and American interest rates. Jean-Claude Trichet, president of the ECB, had a different agenda, however, delicately warning investors not to expect such a rate hike. Analysts quickly reconfigured their models, hoping that the rate hike will merely be postponed by a month, rather than cancelled. The Financial Times reports:

Market expectations still point to rates of 3.25 per cent by the end of the year, but whereas this was a 100 per cent certainty before Mr. Trichet’s comments, the probability fell to 80 per cent afterwards.

Read More: Euro slips as Trichet douses May hike hopes

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EU economic data may trigger rate hike

Apr. 4th 2006

Headlining a recent spate of economic data was the monthly report on EU manufacturing data, which indicated Euro-area manufacturing is growing at the fastest rate in nearly five years. Echoed by other economic indicators, the data suggests that the European economic recovery is slowly feeding into labor markets. On Thursday of this week, the European Central Bank is scheduled to meet to discuss the future of EU economic policy. The consensus is that the bank will leave rates unchanged at this meeting, but will signal the likelihood of a rate hike in May. The Financial Times reports:

The strength of the indices suggested the stronger growth expected to be shown in gross domestic product figures for the first quarter of 2006 would continue into the second quarter.

Read More: EU manufacturing recovery gathers pace

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OPEC diversification gathers momentum

Apr. 1st 2006

In all likelihood, the next couple of years will witness a narrowing of interest rate differentials between the US and Europe. Accordingly, many analysts are predicting risk-averse investors to begin migrating their capital from the US to Europe, which would cause the Euro to appreciate. Leaders of Central Banks have begun to make their own preparations in response to this expected trend. The United Arab Emirates has already announced its intention to increase the portion of its forex reserves held in Euro-denominated assets from 2% to 10%. Other Arab nations, including Iran and Syria, are mulling similar propositions. If these nations ultimately decide to diversify, it could feed back into forex market psychology and hasten the dollar’s decline. Dow Jones News reports:

U.A.E. officials have repeatedly said that if they move out of dollars, it will be because of market dynamics rather than because of politics. Such a move would reduce the risk that the central bank would incur heavy losses should the dollar weaken sharply.

Read More: Threat Of Middle East Reserve Move Stresses The Dollar

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USD harmed by talk of interest rates, diversification

Mar. 30th 2006

Jean Claude Trichet, President of the European Central Bank (ECB) recently cautioned investors to expect EU interest rates to remain at historically low levels in the near-term. Nonetheless, analysts still expect the ECB to raise its benchmark interest rate next month. In fact, interest rate futures, which reflect investors’ collective expectations for future monetary policy, have three rate hikes priced into them. In addition, the last few weeks have seen heightened speculation that Asian and OPEC Central Banks will soon diversify some of their reserves into Euros. Many analysts have opined that the prospective combination of narrowing interest rate differentials and reserve diversification will soon send the dollar on a downward spiral. The Financial Times reports:

The debate was kickstarted by…the central bank of the United Arab Emirates, which may increase the share of its reserves held in euros from 2 to 10 per cent on valuation grounds.

Read More: Dollar dips on narrowing yield gap

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Iran Oil Bourse to open in March

Mar. 3rd 2006

Later this month, Iran will inaugurate its much-anticipated oil bourse, whereby it will begin accepting payment for its oil in Euros, instead of in USD. Many analysts are already predicting that the bourse will mark the beginning of the end of the Dollar’s status as the world’s reserve currency. If other oil exporting nations follow the example of Iran, the demand for USD to settle oil purchases will decline. The central banks of these countries could conceivably begin to hold Euros instead of dollars in their foreign exchange reserves, which would deal a major blow to the dollar. FXStreet reports:

[Iran] has declared war on the U.S. Dollar’s world reserve status. That starts on March 20th, 2006 with their new Petro-euro oil bourse. The Fed will stop revealing M-3 on March 23rd, 2006. Coincidence?

Read More: Is the Federal Reserve Preparing for Iran?

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