How Low Will the Euro Go By End-2010?
July 28, 2010
The euro presently shows a 10% net year-to-date decline against the dollar. At its low of $1.1878 in early June, the euro had dropped by 17.0% since the end of 2009. I do not expect the euro to be weaker than that June level on December 31.
Some analysts are more bearish on the euro than I. Hans Redeker of BNP Paribas caught considerable attention earlier this year with a prediction that the “massively overvalued” euro would sink to parity against the dollar in late 2010. He’s backed off that forecast but, when questioned today in a Bloomberg interview, still predicted a drop to $1.15. The sovereign debt problems of the monetary union’s peripheral members pose a long-term risk to the commonly shared currency, but a good part of that danger is already priced into the exchange rate, which has declined 14% since late November.
It takes time for large currency adjustments to occur. A dollar drop of roughly 50% against the mark and yen in the mid-1980s fostered by a formal G-5 agreement to promote depreciation occupied almost three years. Prior to that, it had taken almost five years for the U.S. currency to double in value.
Let’s suppose the euro does end 2010 at a value of $1.1500 and see how that 19.7% end-2009 to end-2010 decline compares to other calendar year changes over the past thirty years against the euro since 1999 and versus the D-mark from 1980 through 1998. The data show that such a calendar year drop of 20% would clearly represent an outlier. In thirteen of the years, the euro or mark rose or fell by less than 10%. Another 14 of the observations represented year-end to year-end movements of at least +/- 10% but less than 19.9%, and three of the years experienced a change that exceeded plus or minus 20%. However, those three biggest moves occurred in successive years (1985-1987) and involved a depreciating dollar associated with the aforementioned Plaza Accord to weaken the U.S. currency. In only six of the thirty years did the euro or mark fall by as much as 10%, and the largest such move was a 14.3% decline of the mark between end-1996 and end-1997.
The largest net end-year to end-year decline of the yen against the dollar in the thirty years since 1980 was a drop of 13.0% between end-2004 and end-2005. In 2008, the yen rose 22.9% against the dollar, and the yen also advanced by 20% or more in 1985 (26.1%), 1986 (24.6%), and 1987 (31.7%). Those gains were associated with the Plaza Accord and were one cause for the secular deterioration of Japan’s economy after 1989. Incidentally, that horrible aftermath explains why Beijing officials are terrified of accepting a sharp and substantial rise of the yuan.
A 19.7% drop of the euro during 2010 means a 24.5% rise of the dollar, 47% greater than the biggest prior end-year to end-year gain of 16.7% against the mark in 1997. If the euro were to wind up at parity against the dollar this year, the U.S. currency would be posting a 44.7% jump against its main rival in reserve asset portfolios. Such a move would be unprecedented by an enormous degree. In my 35-year career as a currency market watcher, I’ve learned to never say never. Stick around long enough, and one sees many market “moves of the century.” However, I’ve also learned to shy away from bets that require something to happen that hasn’t been observed in the past.
My confidence that a euro drop to $1.1878, $1.15, or $1.0000 at yearend is fortified by another observation. In 2005 when the yen recorded its biggest 13.0% drop against the dollar and in 1997 when the mark fell by 14.3% versus the U.S. currency, generalized dollar strength was a dominant market theme. In 2005, the euro fell by 12.9% against the dollar, and in 1997, the yen dropped by 11.1% against the greenback. The currency market is more ambivalent in 2010, since while the dollar has risen against the euro, it has also depreciated against the yen. In such circumstances, it would be very unlikely to see the dollar post a record advance against Europe’s common currency.
Copyrights Larry Greenberg 2010. All rights reserved. No secondary distribution without express permission.
Tags: BNP Paribas, Euro, Redeker
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I personally think the P.I.G.S fiasco will and has had a very negative effect on the strength of the Euro.