The Euro Will Keep Rallying – Unless Growth Halts and the ECB Eases
Fundamental Forecast for Euro: Neutral
- The early part of the week saw the Euro climb to new highs versus the commodity bloc.
- EURGBP is of interest as it trades at a critical juncture.
- The EURUSD fell then rebounded after the Fed announced its plans to taper QE3.
The EURUSD’s resiliency was on display this week, and a massive Doji on Friday confirms the market’s general lack of interest in driving the Euro much lower (a lack of follow through for the US Dollar after a theoretically bullish event – the first steps towards the Federal Reserve normalizing policy – might be warning sign). The pair only finished down only by -0.50% at $1.3673, after touching as high as 1.3811 and as low as 1.3625 – the lowest since December 6.
With holiday trading conditions setting in for the next several weeks, and the calendar devoid of anything truly meaningful, it’s time to look forward into 2014. Thus far, the Euro has had a strong 4Q’13 – it’s outpacing all the major currencies, and was a hair ahead of the second best performer, the Swiss Franc, at the end of this week (+0.11%). Many issues changed and eventually calmed over the last several months, which initially had the Euro limping through early-2013.
The biggest issue – the Euro-Zone debt crisis – has continued to remain under a tight lid since European Central Bank President Mario Draghi’s “whatever it takes” comment in July 2012. It can’t be emphasized enough the impact this statement has had on market sentiment. While labor markets continued to suffer across the region, growth is starting to show nascent signs of return, particularly in the PMI surveys. Even the inimical political environment that characterized European affairs for the past several years has ‘grown up.’ The future is looking promising for both the Euro-Zone economy and the Euro, so long as growth continues to creep back into the picture.
The ECB has taken steps to ensure that growth continues to work its way back into the region. In November 2013, the ECB cut its main refinancing rate to 0.25%, a new all-time low, as credit growth continued to stagnate, leading to the weakest inflation readings in the post-crisis years. As rate changes typically take around six months before the effects are felt through the economy, we find it unlikely that, in absent of a further increase in deflation/disinflation figures, the ECB will cut rates again, at least in the 1Q’14.
It’s been stated time and again the likely impact the ECB’s shrinking balance sheet – in particular relative to other major central banks – has been and will continue to be profound. The ECB’s balance sheet has declined by -24.6% in the 52-weeks ending December 6, 2013; to contrast, the Federal Reserve’s balance sheet has grown by +36.8% over this same period; and the Bank of Japan’s has growth by +40.7%.
The ratio of the Fed’s balance sheet to the ECB’s balance sheet – which stood at 0.96 this time in December 2012 – is now at 1.72. On a relative basis, the Fed’s balance sheet has grown +79.2% relative to the ECB’s over the past year. Even though the Fed is now tapering QE3, a slightly slower yet continued shift higher in the ratio would support a stronger EURUSD.
Ultimately, if the ECB announces a FLS-like LTRO, it could prove supportive for the Euro. Absent a massive carte blanche liquidity injection like LTRO1 and LTRO2 in December 2011 and February 2012, respectively, measures geared specifically towards faster employment growth, a rebound in the housing market, and a healthier consumer should limit Euro weakness. The ECB is likely to have a very limited scope for easing in the 1Q’14, giving the Euro ample opportunity to appreciate further. –CV
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