The currency wars are really heating up.
The euro has absolutely cratered since European Central Bank boss Mario Draghi gave the green light to quantitative easing (QE).
Now all the talk is of the euro ‘going to parity’ with the dollar. In other words, one euro will buy you just one US dollar. It’s not so long ago that a euro would get you $1.40.
As a side effect, it’s also tanked against the pound. Which is cracking news if you’re off for a holiday in the eurozone this year.
But what does it mean for your investments?
Will one dollar buy one whole euro soon?
There’s no secret as to why the euro has cratered, against the dollar in particular.
On the one hand, the European Central Bank (ECB) has just started printing money to buy bonds. That’s driven interest rates down to record low levels. Money printing plus low interest rates makes for a very undesirable currency.
On the other, the US central bank, the Federal Reserve, is on the verge of raising interest rates (probably). US government bonds also have higher yields than most eurozone government bonds too, which makes the ‘carry trade’ (borrowing in a low-yield, weak currency to buy higher-yielding assets in a strong one) attractive.
However, the speed and extent of the euro crash has been quite spectacular. And now you’ve got investment banks all over the place predicting ‘parity’. It’s the sort of thing that would normally make you think that sentiment had swung a bit far in the ‘too bearish’ direction.
And as James Mackintosh rightly points out in the FT, the euro really shouldn’t be a one-way bet. The euro has a “record high” trade balance – in other words, it exports a lot more than it imports, in terms of value – which should be “a small prop” for the currency. (That’s because all the people buying goods from the eurozone need to sell their currency and buy euros.)
Also, while everyone tends to focus on the misery in the likes of Greece, the economic picture across Europe is simply not as grim as you might think. Consumer confidence and retail sales growth are at very healthy levels.
So the euro has got more than a few things going for it.
The euro isn’t a one-way bet – but it might take a while to turn around
However, you could have said the exact same thing about the dollar a long time ago. The US economy was clearly getting stronger relative to the rest of the world. And it’s been looking a lot healthier than Europe for quite some time.
And yet it’s only really since Mario Draghi started to win the QE fight that the euro began to weaken against the US dollar. So the recent past suggests that the actions of central bankers trump economic reality when it comes to the currency markets.
To be clear, I have no interest in predicting where the euro will go in the short run. As far as I’m concerned, currency trading can be fun, but it’s like poker. A very small number of people can make a profit from doing it, but for most of us, it’s an entertaining pastime. (And for some people, it’s a life-ruining addiction.)
So I’m not saying you should be short or long the euro right now as a trader. But in the longer run, for as long as Draghi is cheering on QE and the US Federal Reserve is thinking about raising interest rates, then I reckon it’s going to be hard for the euro to pick itself up off the floor.
Of course, that might change. The Fed may blink and fail to raise rates – judging by its lengthy track record of doing just that, I wouldn’t want to bet against it.
However, as James Ferguson of the MacroStrategy Partnership pointed out in a recent edition of MoneyWeek magazine, the ECB is likely to have to do a lot more QE than anyone currently expects. So that may well offset any lack of backbone by the US central bank.
The QE trade so far has been to buy the stock markets of those countries whose currencies are being hit hardest. That’s why I’m sticking with Europe, rather than the US. If you’re not already a MoneyWeek subscriber, you can get a catch-up report to bring you up to speed on our views on Europe (and some of the many ways to play it, including currency-hedged options) and other markets, and also get your first four issues free here.
Of course, Europe’s instability could also pose a big threat to markets. We’ve seen that the Greek situation just isn’t going away. My colleague Tim Price has a very gloomy take on the whole story, but it’s worth being aware of how bad things could get – you can read his views here.• This article is taken from our free daily investment email, Money Morning. Sign up to Money Morning here.