Euro Sliding in Tandem with Pessimism about Global and Regional Growth

July 6, 2012

The euro fell more than 2% this past week against the dollar amid deepening gloom about the outlook for growth in the second half of 2012 and next year.  The euro had been vulnerable in the second quarter on the possibilities of Grexit and other ruptures in the common currency arrangement.  Even though the summit of EU leaders at the end of June produced more cohesion than anticipated, subsequent revelations of the latest set of agreements tempered initial market relief.  Equally pertinent, the first week of July delivered a series of weak economic statistics not limited to Europe.  Without decent global demand, Europe’s debt and banking problems will fester. 

Central banks have responded with more stimulus.  Those in China and Euroland cut interest rates, while quantitative easing by the Bank of England was expanded.  These supportive gestures have been reactive rather than anticipatory, however, and therefore cannot be expected to reassure market psychology going forward.  The worst immediate consequence for Japan and the United States of a weaker economic picture in the third quarter involve domestic politics.  President Obama will probably be defeated in November by his Republican challenger, and profound shifts in fiscal and social policy tactics will ensue.  Japanese Prime Minister Noda will find passage of a sales tax increase increasingly unpopular and difficult to accomplish, and his job also will be in great jeopardy.  But for Europe, the stakes are much higher.  Intensifying fiscal strains, greater social unrest and the derailing of the currency union cannot be ruled out.  Euro depreciation makes sense if global growth prospects keep looking more and more bleak.

This year’s peaks in the euro and commodity prices mostly were set in late February.  Since highs on the 23rd or 24th of that month, the euro has declined about 12% against the yen and some 8.5% and 6.5% relative to the dollar and sterling.  Gold has lost 11% of its value (and 17% since cresting at $1911.5 per ounce in late August 2011).  A 23% plunge in oil prices since late February is not being counted upon as a counterweight against the current negative economic momentum and fiscal austerity that lie just ahead.  The People’s Bank of China is taking a more activist role in braking China’s slowdown but started late and will not be complemented by the kind of massive fiscal support from a now-transitioning central government that was implemented in 2009.

One surprising currency market development continues to be the resilience of commodity-sensitive currencies like the Australian, New Zealand and Canadian dollars.  Their net changes against the greenback were minuscule this past week, and declines since late February have been far smaller in size than the depreciation of commodity goods.  Investors will need to carefully monitor long positions in these currencies, lest a catching-up slide unfold.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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