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Euro Dead Zone!
By Mike Conlon | December 9, 2009
What Lies Ahead (Below) for the Euro?
I feel like at times I neglect the Euro, as it’s sort of the “middle child” in the currency pecking order of the risk trade. So while my focus tends toward the more extreme pairs (Aussie & Kiwi for risk-taking, Dollar and Yen for risk aversion), perhaps it’s time to turn my attention back to the Euro.
While the recent move down hasn’t escaped my attention, it appears as though this may be the reversal that has been long overdue. The Euro is an interesting currency in that it is comprised of different countries that both cooperate and compete with one another. This is what gives it that balance, as strong countries tend to balance out the weaker ones. Think of it as automatic diversification.
But what happens when the balance begins to slip? Increased volatility and a move to the downside, which is what we are starting to see now. The reason is that there are more countries that are in economic trouble than there are those that are seemingly economically sound.
The fact that there seems to be a pickup in sovereign debt downgrades to Euro zone members is the catalyst at this point. S&P cut Spain’s rating and Fitch cut Greece’s rating all within the last two days. There is no proof that this will mark the last of the downgrades.
Combine this with already noted economic weakness in Ireland, Iceland, Portugal, and the Eastern Bloc and it makes one wonder who is actually doing well. As of this writing, it appears to be France, Germany, and the Scandinavian countries, although Germany just reported a decrease in industrial production, when an increase was expected.
So while many are correctly predicting that there won’t be a rate hike from 1% any time soon, I wouldn’t necessarily rule out a rate REDUCTION. While it’s no secret that the ECB lost out on the interest rate race to the bottom, it might just be time to loosen monetary policy as more members end up on ratings agency watch lists.
As ECB President Trichet whined about Euro strength as a result of dollar (and by proxy Chinese Yuan) weakness, he did nothing about it. While tasked with keeping inflation at bay, this doesn’t appear to be a problem anytime soon and could in fact prolong recovery if the unemployment and economic picture gets any worse.
Let’s take a quick look at a chart of EUR/USD: (click chart to enlarge)
As we can see, the Euro appreciated mightily against the Dollar until recently when its trend-line has broken. Expect to see further Euro weakness as the ECB scrambles to come up with measures to help stabilize individual economies. This also plays into the “risk aversion” trade, which would cause Dollar strength if the signs of Euro zone recovery seem distant.
Any way you slice, the Euro zone seems to be in trouble and the question now is whether they can enact measures fast enough to halt a potential domino effect.
You can’t be all things to all people, as Trichet is finding out the hard way.
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