Focus on the Euro

June 24, 2011

The perceived insolvency of Greece continues to temper the euro’s strength.  The common currency as of 18:00 GMT today was trading at $1.4176, down from Friday closing levels of 1.4289  on June 17, $1.4337 on June 10 and $1.4625 on June 3.  A 2011 peak of $1.4941 on set on May 4.  The euro has lost ground on key European crosses as well.  It depreciated 10.5% against the Swiss franc between April 6 and yesterday’s record low of 1.1848 and has fallen 1.9% from a 13-month high of 0.9042 against sterling that was touched on May 4.  The euro area economy has cooled but continues to trend positively as a whole.

The euro’s cup is more than half full, nonetheless.  The common currency remains slightly stronger than its year-to-date mean of $1.4027.  Less than thirteen months ago when the Greek debt crisis was already about a half-year old, the unit traded as low as $1.1878, close to its lifetime average value of $1.1977.  Now it is 18.2% stronger than that center of gravity.  The Deutschemark-translation value of the euro is currently 1.3810 per dollar, just 2.5% softer than the priciest value ever attained by the mark, which occurred in March 1995.  The trade-weighted euro is 2.1% above its 10-year average and 29.7% higher than its October 2000 low.

Assessments of monetary policy favor the euro over the dollar.  ECB officials haven’t expressed reservations about apparent plans to implement a second rate hike in early July.  The EU’s appointment of Mario Draghi as the next ECB President with a term through October 2019 lifts one potential uncertainty that might have weighed on the euro during the summer.  Draghi is an MIT-trained economist with a reputation as an inflation hawk and prior experience both as a central banker and investment banker.  The European Central Bank has managed to contain concern about its exit strategy for unwinding monetary stimulus better than the Federal Reserve.  Fed Chairman Bernanke’s second press conference this past Wednesday was not as well received as his first, partly because the message to be delivered was more somber.  The Chairman acknowledged that future growth prospects have had to be scaled back and not entirely for reasons that officials fully understand.  While the Fed voted not to ease its stance additionally after June, a continuing multi-quarter period appears to lie ahead before officials will be able to activate exit plans. 

Lower oil prices usually favor the dollar.  West Texas Intermediate crude prices peaked this year at $114.80 per barrel on May 2 but have declined by 21% since then.  High energy import costs put currencies of economies with large current account deficits at special risk.  The fact that oil prices fell in part this week in response to a bold U.S.-spearheaded release of strategic reserves is an added plus for the U.S. currency.  Commodity-sensitive currencies have retained much of their earlier gains, however.  The Aussie dollar is stronger than $1.05, and the loonie has been on the strong side of parity with the greenback for part of every trading day so far this year.  New Zealand’s kiwi, edged 0.1% lower for the week.

Greece’s situation remains precarious.  The Greek parliament may not ratify the austerity plan whose passage Prime Minister Papandreou seeks, and social violence may escalate if it does. The financial press is full of recommendations from experts advising that it’s best to restructure Greek debt sooner rather than later, and that’s a backdrop that doesn’t offer any near-term possibility for the peripheral bond yield premiums to shrink to manageable levels.  The aura of immediate danger hanging over the European debt problem holds greater credibility than the congressional-White House dispute over raising the U.S. Federal debt ceiling.  The thinking in the latter case is that one side or the other will flinch before the August 2 deadline, because that is what has always happened with debt ceiling deadlines in the past and what happened at the end of last year on the matter of extending the Bush tax cuts.  The irony is that the market isn’t even putting pressure on U.S. politicians, and that lack of strain increases the possibility that the problem will not be resolved by the drop-dead date.  Ten-year Treasury yields are below 3.0% and down almost 40 basis points since the start of May.

The Swiss franc and sterling offer other European choices for investors wishing to constrain exposures to the euro debt crisis.  The favorite of those alternatives should continue to be the franc.  A number of weaker-than-projected British indicators of demand confirm a negative impact from self-imposed fiscal austerity and external headwinds like elevated commodity prices.  Bank of England policymakers took note of this evolving landscape at their meeting earlier this month.  While a strong eight out of nine policy committee members voted again not to raise the asset buying limit, several indicated more quantitative easing could become necessary in the future.  Britain’s twin current account and fiscal deficits will exceed 10% this year, while the sum of Switzerland’s government and external balances will be above 10% too, albeit in the black rather than the red.  U.K. inflation should touch 5% this year but will not prompt a rate hike.  Swiss inflation barely has a heartbeat, and Switzerland also compares favorably against Britain in comparisons of economic growth.

The Japanese yen has been trading against the dollar as if that relationship were institutionally set by the dictates of a fixed parity regime.  Such is happening even though Japan’s Ministry of Finance admitted to intervention support of only JPY 692 billion (or roughly $8.5 billion) during January-May, all done on March 18.  The high-low band width of dollar/yen was just 1.0% this week, 1.3% in the prior week to June 17 and 1.0% in the week to June 10.  The yen’s successive highs over the first four weeks of June were grouped very tightly at 80.03, 79.67, 80.00, and 79.98 per dollar this past week.  Japan’s $1.14 trillion stock of international reserves was $48 billion greater at end-May than three months earlier.  The yen became no weaker than 80.79 per dollar this past week, indicating that while having difficulty advancing beyond 80 per dollar, it likewise has shown considerable resilience against any tendency to reverse trend.  So the yen has stayed near historic record highs during a disaster-induced recession.  It now appears that Japan’s supply side is bouncing back faster than anticipated.  In the future, therefore, it could become harder to prevent yen appreciation.

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.

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