Nudging over 1.30
So what I am talking about here? Well the Euro/Dollar of course! Consequently, the common European currency rose, according to the FT, to a 19th month high against the dollar. Now what should we think of all this then? Well it is obviously not a new thing here since the Euro has been climbing steadily against the dollar the past months. The US economy has slowed down considerably in the 3rd quarter which have narrowed the growth gap between the US and the Eurozone. Indeed the Eurozone is probably growing a bit faster than the US going into to 2007. So is it all good then? Can the Euro and other, particularly Asian, currencies really take up the slack for the falling dollar? Well the FT's comments make me wonder what planet I have been on lately because I have not been receiving the same data as they have it appears; let us scrutinize the following ...
(from the FT linked above - bold parts are my emphasi)
The single currency rose as high as $1.3085 against the dollar, exceeding its previous high of the year by more than a cent.
Recent economic data has indicated continuing strength in the eurozone economy, while the US appears to be heading towards a slowdown. German consumer prices looked likely to add to this picture as six of the country’s states reported rising inflation trends.
Added to Thursday’s stronger-than-expected Ifo business confidence survey, interest rate expectations moved in favour of further gains for the euro.
“There is scope for further advances in the interest rate market in our view, with risks to the European Central Bank rate outlook on the upside,” said Henrik Gullberg at Calyon investment bank. “This should further the bullish euro environment.”
Ok the ECB is raising in december we all know that but not because of inflation per se; the inflation in the Eurozone is well below the 2% target range going into 2007 on account on falling headline prices. In fact, the ECB has reverted to aggregate monetary targeting and future underlying inflation pressures as result of a perceived upward push in labour unit costs. Meanwhile, where is all the positive data on German consumer spending which suggests that a rising Euro in fact is not a very bad thing for Germany's export driven economy at this point going into 2007? No seriously, please show it to me! This is not to speak of Italy where consumer spending is also persistingly dropping; what good will a rising Euro do here I migth ask? Even France who is running a trade deficit is beginning to squeal a bit about how the ECB policy is hurting the exports. This of course is not important since normalization of interest rates remains the main objective.
A lot of people are hard at work at the moment talking about the crash of the US economy and the dollar meltdown and how it was only a matter of time before the hammer came down on the US economy as the US consumer reigned in the credit margin on their houses and Accept Cards. However, what people do not understand is that for the US dollar to fall others must appreciate. The RMB is obviously a case in point here and the dollar peg is obviously being pushed and strained at this point, but it remains! However, what about the Yen and the Euro? Do we really expect the Euro to take on the correction of the US trade deficit at this point? If that is your discourse you should by no means be looking to the US for a crash! And the Yen? Well, my utter inexperience in currency markets notwithstanding I really do not see that anyone at this point can seriously argue that the Yen will take on any sustainable appreciation on its back. Please correct me if I am wrong of course.
So in essence what I am saying here is that the fundamentals at this point simply do not merit the expectations of any short-term correction and re-balancing of the imbalances.
Stephen Jen pretty much agrees with what I am saying over at the GEF, or I with him :). In any case, this is important to keep in mind ...
I believe that investors may have been too easily excited by the term ‘reserve diversification’. In my view, this is a very gradual process, dictated in part by the liquidity of the targeted market. It is very difficult for Asian central banks to diversify in size into markets that are small. Our analysis suggests that most of the diversification we will see in the coming year or so will be cross-asset diversification and not cross-currency diversification.
In sum, the point I stress here is that, even though I am cyclically bearish on the dollar, I am still structurally constructive on the dollar.
However, I still feel that Jen needs to take a long hard look at the Eurozone if the ECB really goes a ahead and raises up to 4.00% in the first quarter of 2007.
There is a good deal of momentum in Europe and it is likely to register 2.6% growth this year. The impact of the German VAT hike may not be severe enough to arrest this growth in 2007. The ECB, as a result of cumulative above-trend growth of 1.9% in 2007, on top of this year’s performance, should bring the terminal refi rate to 4.00%, compared with the 3.50% that we had thought previously.
I am not nearly as optimistic as Jen is here.