Friday June 3, 2005 - 13:22:57 GMT
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Forex: Talking The Other Side Of The Trade
Talking The Other Side Of The Trade
No worries I have not abandoned my longer-term bear view on the dollar. But the euro has been exposed this week for what it really is...an unequivocal
monetary success and a political birds nest. When European politicians are calling the shots for the euro it invariably sinks. When the ECB is calling the shots as in most of the time it is a reasonably strong currency. I simply ask was it ever anything else? The answer is no. But some things get tucked away while other things that drive markets prove compelling...unsustainable twin US deficits and the needed adjustment in the dollar was a compelling story and surely will be again ahead. But now it is not. Now Europe's two powerhouses, Germany and France, are scrambling to win back the confidence of the people who have grown tired of high unemployment, erosion of state benefits and Anglo-drift...emulating UK and US economic model.
The danger ahead is that Chirac/Villepin and Schroeder running on desperate blow budgets out of the water with an attempt to buy measurable jobs growth. Alternatively they could take an even darker path of importing prosperity with deliberate efforts to weaken the euro a lot more. Or they can do nothing and wait to be voted from office. Villepin has promised to win back the confidence of the people in 100 days. That is after curing cancer and unlocking cold water fusion.
Not even a stingy ECB will be able to stop this struggle for political survival. At best they can conduct damage control. Asserting authority over currency policy (including verbal and real intervention if needed) will be necessary if politicians take the "easy" route to employment growth.
But no this is not the end of the euro as some have claimed. Central banks are not going to reduce euro reserves...they are likely to continue to add
to them despite the political crisis. What it means to me is that the euro is headed into a new lower range (lower than I thought a week ago, for the record) of 1.19-20 area on the downside and 1.24-25 on the topside.
Furthermore, the more the dollar strengthens (and on a broad basis with euro weakness the catalyst) the more US external imbalances are compounded, and the greater the likelihood of a disorderly adjustment later.
And to fully expect a major sustainable downtrend in euro/dollar from current levels you need to really like chances of US budget deficit reduction, a sound US housing market where home ownership justifies enormous household debt loads, reject Dallas Fed President Fisher's belief that Fed tightening is nearing a pause and the yield curve is flat because of unprecedented confidence in the Fed getting it right (a Fed affected permanent reduction in risk). We all know the rather pathetic fundamental story in the Euro Zone...it is being aired regularly in just about every bit of Cyberspace. But you need to buy into a Panglosian (best of all possible worlds) view on the US to expect major new dollar gains and euro losses from here (1.2275).
On the surface US fundamentals appear strong, and very strong next to Europe and Japan. But probe under the armor and the knight is soft and vulnerable. Sure it sounds convincing when pundits hit the airwaves (Jack Welch today) saying "where else is the world going to put surplus savings but in the US?" However, in a world where risk aversion soars and the sustainable quickly turns unsustainable, creditor currencies come out on top and debtor currencies come out on the bottom. Always.
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