Monday August 18, 2008 - 04:15:22 GMT
Share This Story
FX Solutions - www.fxsol.com
The Euro Bubble
The euro has fallen 8.6% in value against the dollar in
month, 4.3% in seven trading days. Currency markets are highly speculative and
are not usually spoken of as having bubbles.
But what else should we call a market that adjusts at this speed?
The fundamental market view since the credit crisis blew up
last August was that the United
States economy would be punished by the
combined housing, credit and financial crises. This view was responsible for
the year long ascent of the euro against the dollar, or if you prefer, the fall
of the dollar against all its trading partners.
was supposed to collapse, driven to recession by the moribund housing market,
job losses and retreating consumer spending; the Eurozone would falter but not
fail. Why else buy the euro?
Central bank policies on both sides of the Atlantic
would flow from this difference in economic outlook. The Fed governors would
have to relent on inflation because of the weakness of the US economy; the European Central
Bank (ECB) could retain its traditional German adamancy against inflation
because resilient Eurozone economies would deflect criticism of its anti-
growth bias. This view was not only prevalent in the currency markets but in
many ways this was the Fed and ECB view as well. The potential for reverses in the American
economy, in addition to the strains on the financial systems, was the reason
Bernanke so quickly and dramatically cut rates.
The moderate but steady Eurozone growth relieved the ECB of the need to
support its economy and the ECB actually raised rates 0.25%.
The rate cuts by the Fed were not a rescue for the banks but
for the economy on which the banks depend.
No amount of central bank liquidity in whatever form can rescue the
financial system if the underlying economy is bankrupt. The asset backed
securities market, which created the initial problem, could not stabilize until
the housing market stopped falling. If mortgage default rates had continued to
rise then the mortgage potion of the asset backed paper which was spread
throughout the market became more and more worthless.
An economy in
recession especially a deep recession destroys jobs and the ability to service
residential mortgages. In cutting rates the Fed was taking action against the
long term scenario that was not evident last August but was a clear threat
given the emerging fragility of the financial system.
If the expectation that the Eurozone GDP would be less
affected by US problems was plausible maintaining that idea in the face of
skyrocketing oil prices was not.
There is no broader measure of an economy's production than
GDP. Eurozone GDP was negative in the
second quarter. Until Mr. Trichetâ€™s admission less than two weeks ago negative
EMU growth was not part of the currency market scenario. Now it is.
The Harmonized Index of Consumer Prices, the EMU wide
measure of inflation, dropped 0.1% on an annualized basis in July. One tenth of a percent is a minor amount. But
remember Trichet's comment of several months ago that inflation will be a hill,
with a down slope in the future. The
expectation of the ECB planners is that inflation could subside of its own
accord if the economy slows and external prices pressures, primarily oil, fade.
Is this the beginning of that decline in inflation? The astronomical rise in oil prices has
The ECB is no Reserve Bank of Australia (RBA). You will not
hear from the heirs of the Bundesbank what traders heard from RBA deputy governor
Ric Battelino that â€śWaiting to see a fall in inflation before we start cutting
rates would be too late.â€ť But it is true for the ECB as well as the RBA. Second
quarter GDP is proof. The ECB needs to
change its rate policy. It cannot wait
for the return of 2.0% target inflation before it acts. Unfortunately its
credibility also needs a discrete interval before it can move to a rate
Facts are stubborn things.
American second quarter GDP was 1.9% and will likely rise to 2.5%
because exports were stronger than estimated for the original number. Eurozone
GDP was -0.2%. These are not facts that
support a euro north of 1.5000. The
decoupling fantasy has been firmly debunked. Why did it ever become
current? Why was oil at 147.00? For the same reason -- the traders, whose
cumulative decisions those prices represented made more money long than short.
It seems simplistic. But markets use facts as reference points not absolute
measuring devices. Rising demand in the
oil markets does not predicate a specific price; it means traders would rather
bet long than short. When the bet is
worn-out, when it is undermined by facts, the market shift is like an
The fall in the dollar and the rise in oil prices were not
unrelated. The weak dollar did not cause oil to strengthen but it added to an
oil traderâ€™s disposition to buy futures. The dollar did not rise because of the
fall in oil prices; in fact oil started falling well before the dollar began
its spectacular ascent. But the collapse
in oil prices did help convince currency traders that the weak US/strong
Eurozone scenario was without foundation. Sometimes a clear fact can destroy
months of unclear speculation. Eurozone GDP was the immediate cause of the euro
decline, but the signs had been gathering for months.
Now that the underlying view of the market has changed what
is the future of the euro? Mr. Trichetâ€™s
warning may well come to pass, we may see at least two quarters of negative
growth in the Eurozone. If US
growth remains moderate, above 1.0%, then the euro will suffer by comparison.
What portion of the US
second quarter GDP was supported by Federal stimulus checks is hard to tell.
But as long as the US
remains positive and the EMU does not, the euro will fall.
If American economic growth becomes negative in the last
half of the year, the euro will not recover.
If both the US and Europe are in recession in quarters three and four
the benefit of the doubt will have to go to the US for a quicker recovery. In addition to its structural advantages of
flexible labor markets and lighter regulation the US has a growth responsive central
bank and the Eurozone does not. Which
policy is correct is not the question. But which policy will produce a faster
return to economic growth is one of those stubborn facts that cannot be
ignored. US growth prospects are better than the Eurozone. And the prospects
for the dollar will continue to improve until that changes.
Forex Trading News
Daily Forex Market News
Forex news reports can be found on the forex research
headlines page below. Here you will find real-time forex market news reports
provided by respected contributors of currency trading information. Daily forex
market news, weekly forex research and monthly forex news features can be found
Real-time forex market news reports and features providing
other currency trading information can be accessed by clicking on any of the
headlines below. At the top of the forex blog page you will find the latest
forex trading information. Scroll down the page if you are looking for less
recent currency trading information. Scroll to the bottom of fx blog headlines
and click on the link for past reports on forex. Currency world news reports
from previous years can be found on the left sidebar under "FX Archives."