From the September 01, 2012 issue of Futures Magazine • Subscribe!

All eyes on euro’s slow-motion train wreck

Fundamental Eurozone data is pointing to a rapid regional slowdown, Popplewell says, noting that Eurozone companies had cut output for the sixth consecutive month in July. “One of the other things that people, and especially capital markets, are focusing on quite heavily is the flight of cash,” he says. “Everybody is very fearful of Spain. The market has come to the realization that Greece can be and should be cut loose, but the market is very fearful of a sovereign handout to Spain because of its prominence on the global ladder.”

A weaker euro will help the periphery of Europe by easing monetary conditions and helping to stimulate exports, says Marc Chandler, global head of currency strategy for Brown Brothers Harriman & Co. He notes that U.S. fund investments are leaving Europe.

“It is also part of the solution,” he adds. “The euro has been overvalued for the better part of a decade. It probably needs to be undervalued for some time.” Chandler notes that the Organization for Economic Co-operation and Development (OECD) and IMF measures of purchasing power parities recently put the euro at about 3% undervalued. This is negligible because the currency of a major industrialized country typically is plus or minus 20% on the scale (see Trailing the field,” below).


Of the G10 currencies, the euro currently is the only one that is undervalued against the dollar, Chandler notes. “Most of the currencies still are overvalued against the dollar,” he says. The most overvalued now is the Australian dollar at 38% while Norway is almost as high at 37%.

“What’s happened recently in a big kick to the head of mean reversion trades is that the euro was overvalued and now is slightly undervalued,” Chandler says. “There also have been very clear trends of Australian dollar higher and euro lower in momentum trading and there have been some carry trades because there are some countries that have negative interest rates.”

For example, he notes that Germany’s recent two-year yield has been -5 basis points while Switzerland’s has been -56, Denmark’s -33 and Finland’s -2. “So basically what that means is you get paid. We used to think that zero was the lower bound of interest rates, but what’s happened in the recent period is we’ve seen negative interest rates of the creditor nations in Europe,” Chandler says. “For the first time, Germen and French two-year interest rates are below Japan’s.” 

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