Lately, I’m getting annoyed when people ask me, ‘What’s up with the euro?’ The more important and ultimately revealing question is, ‘What’s up with the U.S. dollar?’
Despite the fact that the USD has been weakening steadily for the better part of eighteen months, analysts only really started talking about stabilization in September. The bubble of optimism was punctured in late November as Thanksgiving weekend brought dollar weakness and the highest EUR/USD price since March 2005. Add into the mix a strong Non-Farm Payroll report on Dec. 8 and you’ve got a veritable turkey, which caused movement of over 350 pips in less than a week. That one week stunned experts and emptied trading accounts.
Recently, in response to the subsequent euro strength/dollar weakness, European Central Bank President Jean-Claude Trichet indicated he was “closely monitoring developments,” a phrase that in the past has presaged rate increases. Analysts speculated that a pause in rate hikes would have weakened the euro, but those speculations were diffused by Trichet’s hawkish statements.
Since early December, the EUR/USD has begun to establish a comfortable trading range that is well above what was seen in 2006.
Mid-month, the euro edged upward against the U.S. dollar after a report showed that inflation in the Euro zone remained at the European Central Bank’s target ceiling in December.
The euro bought $1.2935 in afternoon European trading, compared with $1.2923 late Tuesday, after the Eurostat, the E.U. statistics agency, said that inflation in the 12 countries that used the euro in December stayed at 1.9%, unchanged from November. Eurostat said higher costs for natural gas were the biggest single factor in the rate, but also cited more expensive restaurants and cafes, electricity and vegetables after a rainy summer ruined some crops.
The euro’s rise was modest after the U.S. Federal Reserve reported that industrial production rose by 0.4% last month after two months of 0.1% declines.
So what does the rest of 2007 hold for the USD?
Industry analysts point to many factors while trying to project the future of the dollar and the economy for 2007. Some of the interesting ones I have heard in recent weeks include:
The second half of a presidential cycle has strong tendencies to be bullish.
If the current U.S. administration pulls money out of Iraq, it will be redirected back into the U.S. economy.
In the United States, we are currently experiencing a long period of economic expansion, but all long U.S. economic cycles have been followed by recession or depression, with calendar years ending in “7” or “0” having the highest probability of being down years.
Well, the good news is there is some sort of consensus between economists about this year’s economic forecast. The main negative factor for the U.S. economy seems likely to be the housing slump, and the Fed is expected to focus closely on labor and inflation numbers. But the biggest wildcard in this calculation will be the value of the U.S. dollar. If banks, foreign investors and traders sell the USD, the U.S. economy will likely take a solid beating.
For instance, take into consideration that the U.S. dollar has been devalued almost 30% against other foreign currencies in the recent past, meaning countries like China have lost almost $300 billion simply by holding U.S. dollars in reserve. The U.S. has made no indication that it plans to reduce deficit spending or pay down any existing debt without printing money to pay it off. Should China decide to employ an aggressive selloff of U.S. dollars it is likely many other countries will follow suit.
Not as bleak as it looks…
Despite the weakening housing market, the employment climate seems to be holding steady. The jobless rate reached a five-year low of 4.4% in October 2006. While this doesn’t promote optimism in some analysts, it will likely be one of the key numbers influencing the Fed’s decision in lowering interest rates.
Federal Reserve Bank Chairman Ben S. Bernanke has already indicated that rising labor costs are also on his radar this year. Some economists speculate that rising wages could be the latest source of inflation. While no one disputes that inflation is a concern for the Fed, there are opposing views on the subject. For instance, another group of analysts believes that inflation will ease in 2007. This has lead to widely differing gross domestic product (GDP) forecasts from analysts, but most agree that the beginning of 2007 will be the most challenging half.
On a brighter note, many analysts are quick to point out healthy numbers in business investments and exports. Right now, there appears to be sufficient inflow from foreign sources to fund the U.S. deficit. And it also has been noted that the economies in the G7 countries are averaging approximately 2% to 3% GDP, which points to equalization of the growth differential.
And perhaps the most discussed bright spot is the strength of the stock market, which has generally withstood the cooling housing market and other dollar strains. Yes, you may still wonder about and watch the euro, however to find out what is happening to any currency, find out what is up with the dollar.
Marilyn McDonald
Director of Marketing
Interbank FX
marilyn@interbankfx.com
www.interbankfx.com
