The €uropean



Where is the euro going?

             When asked about the outlook for the euro, exchange rate analysts seem quite puzzled. Out of the ten professionals surveyed by this magazine, some bet on a further strengthening of the common currency, while others argue the rally of the last few days is just a temporary apex which opens the door to a medium-term setback.

             All in all, consensus opinion is that the euro should not have a strong trend, neither on the upside nor on the downside, but perhaps a slight positive bias is in the cards.

             Let's start with the bulls.

             For most of the optimists, the strength of the common currency is the mirror image of the weakness in the dollar, the pound, the yen. Says David Bloom of HSBC: "England, the US, Japan and Switzerland print more and more money and I don't want to have a currency if you're printing more and more of it, otherwise you buy Zimbawe. The only major block which is not printing so much money is the eruozone. Accordingly, the path of least resistance leads to a stronger euro.”

             The bounce in the euro was also aided by market positioning shifts, argues Gianmarco Salcioli of Barcleys Bank: "Speculators were mildly long the dollar and when the Federal Reserve announced its massive quantitative easing operations, last week, the news precipitated a short-covering rally in the euro.”

             However, the bullish argument around the euro rests above all on the fact that the other central banks are printing money as if the world had to run out of trees. Thus it may be useful to summarize the figures: The Federal Reserve announced initiatives amounting to $1.15 trillion (GSE-backed debt by $750 bn, agency debt by $100 bn, $300 bn of Treasuries which coupled with the $1 trillion TALF program mean the Fed's balance sheet will take off by some $2 trillion, or about 14% of GDP, over the coming months.  

             In similar fashion, the Bank of England is employing £75 bn of quantitative easing operations, or 5% of GDP, while the Bank of Japan has just promised an increase in government obligation purchases by 4% of GDP.

             "On the contrary, the European Central Bank is not willing or cannot adopt a similar easing stance", says Unicredit's Roberto Mialich. "In part because the ECB is barred from purchasing government bonds at auction, and even if it had to find a shortcut, which bonds would the ECB buy? German? Italian? Greek?"

             There's another shift moving against the dollar: its rally, between mid-2008 and early 2009, was mainly driven by short-term capital flows. The global financial crisis set off a tremendous transfer of money out of the risky assets and toward the "safety" of U.S. T-bills. The move was strengthened by a repatriation of capital from U.S. managers.

             But it seems the tide is changing. According to Harvinder Kalirai of BCA Research, "Data from the U.S. Treasury show that early in 2009 foreigners were net sellers of U.S. T-bills for the first time since late 2007 and U.S.-based investors sent capital abroad for the first time since mid-2008."

             The trend is particularly worrisome because long-term capital inflows in the US are weak. "Foreign purchases of corporate bonds, agency bonds, equities and Treasury bonds are all slowing", Kalirai says.

             Moreover, holders of U.S. Treasuries see the risk of a capital loss when the Federal Reserve stops buying long-term government obligations. “Therefore,” says Marcus Hettinger of Credit Suisse, “investors need to be compensated with a higher opportunity for currency gains in the long-run. That is the dollar has to go down.”

             If some analysts claim that the euro is going to appreciate because the dollar, the pound or the yen are inherently weaker, other experts bet that the common currency will decline because the European authorities are less stimulative than their main counterparts.

             "I think the dollar ought to rise in the short-run," says David Kotok of Cumberland Advisors. "Both the monetary expansion and the fiscal stimulus are unprecedented in the U.S. and this suggests to me that America ought to break out of the doldrums before the other economic blocks, giving support to the dollar." 

             Asmara Jamaleh of Intesa Sanpaolo has a similar reasoning: "If the U.S. has adopted such extraordinary steps, it means economic activity worldwide is weaker than currently envisioned. Sooner than later, the European Central Bank will cut interest rates, perhaps already in April and then in June, moving the base-rate from 1.5% to 1% by then. The euro bounced because the market was unprepared to the Fed announcement last week. But as soon as it gets accustomed, the euro should fall back of its own account to 1.25-1.30 in a few months".

             As you see, there is no consensus opinion around on the outlook for the euro. Perhaps there is only a slight bias in favour of the common currency, and a more shared view that whether the euro moves up or down, the net trend is unlikely to be very strong.

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