Get Ready for A Higher Euro

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Shutterstock photo

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Usually I tend to avoid making long term, dramatic predictions about the currency market. As somebody whose background is in a spot forex dealing room it is not a natural thing for me to do. When I worked in that environment it was a source of amusement to all of us that when we mentioned what we did, say at a party, people would frequently ask something like “Oh, I’m going on vacation to Thailand in a couple of months. Should I buy my Baht now or later?” The stock response that I developed was that I only dealt in Cable (GBP/USD) and, more importantly, was paid to know where it was going in the next 2 minutes, not the next 2 months.

That said, though, at times there are big picture, long term factors that can convince me that a particular currency is set for a sustained move in one direction. That is the case now with the Euro, where it looks like a period of relative strength is about to begin.

As you can see from the 1 Year chart above, the Euro began its decline against the dollar around this time last year. That was essentially for two reasons. Firstly there were significant problems emerging in the Euro zone economy. Economic activity was slowing and there were signs of deflation taking hold. That situation probably got worse than it should have due to a delay in response by the ECB. Actually, blaming the central bank is probably not fair; it was mainly Germany that was the problem. German opposition to accommodative monetary policy is understandable given their historical knowledge of the dangers of inflation, but it meant that the ECB failed to offer stimulus until the picture looked dire.

Ironically in some ways the policy prescription that the ECB finally did offer, their version of QE, then contributed to the Euro weakness by effectively diluting the currency. The effect of that, certainly against the Dollar, was exaggerated by the fact that the move coincided with the end of the asset purchase program by the Fed.

To refer to the chart again, though, you can see that once all of that was priced in the Euro became pretty stable. We have essentially been in a pretty tight range of around 1.08-1.16 since early May. (Yes, I do understand that 8 big figures is a lot in forex terms, but compared to the 30 big figure drop that preceded it, it is a tight range). EUR/USD almost has to break out of that range soon, and a sharp move up over the next few months now looks like the most likely direction.

Last night, in a speech in New York, ECB President Mario Draghi said that the Euro zone had returned to “…sustained growth under the impulse of our monetary policy.” That is obviously good news all around. A vibrant Europe can offset a lot of emerging market woes, but Draghi’s saying it suggests that the same two factors that drove the Euro’s decline, economic growth and monetary policy will now be pushing it back in the other direction.

If he is right and the growth is set to be “sustained”, then that will obviously give the impetus for a move up. In addition, though, you can be pretty sure that the ECB, unlike say the BOJ, will get caught in the trap of leaving QE in place for too long and creating a dependency. The Germans are still the most powerful economic force in Europe and they will be chomping at the bit to tighten monetary policy as soon as possible. Draghi’s language in the New York speech suggests that they are about to get their way.

If you look at it from that perspective, then even the prospect of higher interest rates here in the U.S. is not a threat to a higher Euro. If anything it could even be a contributory factor. A 25 basis point Fed hike will hardly cause a surge, but it could be enough to allow the German influence on the ECB to prevail, and, in the light of that “sustained growth”, for that to result in tightening in Europe.

The way looks set, then, for a fairly significant move up in EUR/USD over the next few months. If Draghi is right and economic growth really is strong, then investors will be looking to take advantage of the situation. The recent weakness in Euro stocks makes that even more tempting, so a non-hedged fund such as the iShares Euro zone ETF (EZU) is doubly appealing. However you choose to play it, though, it seems that Mr. Draghi is giving us a clue that we would be foolish to ignore.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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