Category — Western Europe

As the U.S. dollar fell to record lows against the euro last week, technical analysis may indicate an earlier than expected rebound in the short run. Last week traders speculated long-run rebounds due to the U.S. economy benefiting from a weak dollar and from pressure on the ECB by Nicolas Sarkozy to cool a strengthening euro. But as traders have been eyeing the Relative Strength Index (RSI) on the EUR/USD pair, there is a possibility of a short-run rebound.

The RSI measures the strength of a currency pair price movement typically within the past 14 days. When the RSI is over 70 there is a good chance the price movement will fall. At over 70 most sellers who have been looking to sell perceive the current price to be the best price. On the other hand, buyers will likely wait for the price to fall when the RSI is in fact over 70.

Thus, in the context of the current EUR/USD pair, the RSI is at 76.34 today hinting at a future fall in favor of the dollar. The U.S. currency did in fact make a small gain to $1.3817 per euro this morning. This level is up from last week’s record low of $1.3845, but not enough to indicate an actual rebound. Nevertheless, the high RSI value may indicate a rebound sooner than expected.

Currency Outlook and Strategy:
On July 25^th, the National Association of Realtors is due to report figures on last month’s existing U.S. home sales. It is expected that U.S. existing-home sales have fallen the lowest in 4 years. This could further hurt investor confidence in the dollar. Looking across the Atlantic, European Central Bank Executive Board member Lorenzo Bini Smaghi states he is not worried about euro appreciation. But Nicolar Sarkozy, newly elected French President, thinks otherwise.

Tim Shea, currency analyst at FXCM, concludes: “This week in the Euro looks very quiet news-wise. We’ve got next to nothing on the European calendar, and pretty much just housing data and GDP in the USA. So, watch the housing numbers and the Dow for some direction, and don’t forget about $75 per barrel oil.”  

It seems like every day the euro hits another high.  At least, that’s been the story of the forex markets for the last five days.  A combination of dollar weakness and the market’s belief in the Eurozone economy has pushed the euro to new heights.  Yesterday was no different.  Bear Sterns officially warned their hedge fund investors that there was no value left in the fund.  With fears of the subprime crisis already strong in their minds, traders were worried that foreign investors would seek to move away from US assets.  Especially after the recent diversification of foreign exchange portfolios (basically, the selling-off of US Treasuries), the Bear Sterns news triggered a dollar decline.  Even the poor German ZEW survey released yesterday did little to stem US losses.

But today’s news may signal a top in the EUR/USD pair.  Consumer prices in the United States rose 0.2% in June. It is the smallest gain in five months but still a reversal from the drop in headline PPI seen yesterday.  Core prices also rose 0.2% versus an expected increase of 0.1%.  Housing starts also rose 2.3% this morning, providing further support for the greenback.  Lastly, Fed Chairman Bernanke is scheduled to give his semiannual report to Congress at 10:30 AM.  Today’s data probably eliminate the possibility of interest rate hikes in the near future, leaving Bernanke free to remain hawkish on inflation.  That’s why DailyFX.com reports that his speech is likely to be dollar bullish.  EUR/USD has been trading within a range of 80 points for the last five days, but if Bernanke’s speech goes as expected, we could see a dollar-positive breakout.

Euro bulls should also be concerned about recent developments regarding the European Central Bank.  New French President Nicolas Sarkozy has called for European finance ministers to be granted more influence in monetary policy decision-making.  The most direct consequence of such a move would be a loss of political independence for the ECB, and that would not be good news for the euro.  German policy makers have traditionally been for an independent central bank, but a recent Bloomberg.com report suggests that German Chancellor Angela Merkel may be coming around to Sarkozy’s viewpoint.  ECB President Jean-Claude Trichet has warned against the disastrous consequences of such a development, even suggesting that it may violate the European Commission Treaty.  This is an important situation for traders to stay on top of because if Sarkozy is successful in imposing political control upon the ECB, we could see the bottom fall out of the euro soon afterward.

European Central Bank President Jean Claude-Trichet spoke to a group of students and economists recently on the “overwhelming success of the euro.” Europe as a whole is definitely going through a boom period right now with unemployment in the continent at a 25-year low and steady growth. Much of that success, Trichet claims, should be credited to the unified economic and monetary policy. I want to spend some time this morning talking about that assertion and how the euro has been good (and bad) for Europe.

Now the economic virtues of the European Union are numerous, but I want to just focus on the currency today. One of the advantages of the euro is that weak economies get to piggyback on strong ones. And by strong ones, I mean Germany. For the last 60 or so years, Germany has been the engine that drives European growth, and its currency, the Deutschemark, has been Europe’s most stable. What the euro does is it allows countries like Italy, which had a notoriously bad currency, to benefit from the international confidence in German stability. Germany’s reputation basically grants a halo effect to the rest of Europe. This is essential for the central and eastern European countries because as emerging markets, their currencies might otherwise be subjected to dangerous volatility levels.

Another benefit is the political independence of the European Central Bank. Before European monetary policy became aligned, the central banks of many countries were headed by the finance ministers in those countries. But finance ministers are politically appointed, and so the economic and monetary decisions were often dependent on political gain or loss. The independence of the ECB from European governments has allowed for more stability in monetary policy. This is an especially important front to pay attention to as French President Nicolas Sarkozy continues to push for more input from finance ministers. Let’s hope that ECB can withstand this misguided effort.

While the stable monetary policy has been mostly a good thing for Europe, it does have its share of problems. A unified monetary policy eliminates some independence for individual areas. If most of Europe is going through a bust cycle, the bank will lower interest rates. But if Belgium is experiencing growth, this decision will lead to inflation in Belgium.

One great example of this scenario is Germany after re-unification. The government faced a need to invest in what used to be East Germany, and increased investment led to inflationary pressures. The German government needed to raise interest rates to combat this threat. France faced no such threats, but had to raise interest rates as well to maintain the integrity of the fixed Exchange Rate Mechanism (ERM). The French economy experienced a recession, and plans for a unified monetary policy almost fell apart eight then.

This problem is evident today as well. Most western European economies are stable and developed. Growth is consistent, but not especially fast. Unemployment and inflation are usually at manageable levels. But the newer EU countries, those from Eastern Europe, are at a different stage in their economic growth. They are, as a whole, growing faster as developing countries. Ideally, the different parts of Europe would have different monetary policies to accommodate the different conditions, but the euro would make that impossible. Sharing a currency means sharing a monetary policy. So while the euro is mainly a good thing, it might not be a good thing for everyone involved.

Over the past twenty days the Australian Dollar has advanced approximately 600 pips against the euro. The market is expecting Reserve Bank of Australia Governor Glenn Stevens to raise rates above 6% compared to the the euro at 3.25%. Inflation has been higher than the 2-3% Mr. Stevens wants. Rises in commodity prices have also helped Australia as they export a great deal of metal and other raw materials.

Related Bloomberg Article

As oil prices have been falling in the last week or two, so have the currencies of the heavy oil exporting countries including the Canadian Dollar and the Norwegian Krone.

The chart to the right shows the last year of price action for the EUR/NOK. With oil prices tumbling and Norway being a key exporter of oil, the change shows through in the strength of the Norwegian Krone. Another primary concern is the central bank rate for Norway. Prices actually declined in the month of August meaning that the year-on-year inflation level fell from .6% to .4%, below the consensus of .6-.7%. With inflation being a key ingredient for rate hike reasoning, this news does not bode well for increasing rates.

EUR/NOK = 8.382 at time of post

EUR/JPY pushes up 160 pips since Friday morning (100 pips this morning) to 149.73, making a new all-time high. Most currencies rallied against the dollar, but the Bank of Japan said it will move slowly before hiking rates again. This along with rising oil costs keep the Yen down.