Revenge of the dollar

Midyear FX outlook

As German Economy Weakens, Eurozone Wobbles

The 18-member single currency, the EUR, is under pressure from weaker activity data and asset market underperformance. The unit is currently within striking distance to this year’s low in January (€1.3473). Any momentum through key support levels for the EUR(CME:ECU4) outright should be capable of dragging both the JPY and GBP higher through significant resistance levels on the cross play.

Short of printing money, what else can the ECB do to prop up the currency bloc’s uneven recovery? An accommodative fiscal policy could inject volatility back into the EUR trade and a shift in interest rates would aid the euro by weakening it but there are no guarantees.

Recurring soft data has exacerbated the situation of late with the Eurozone’s three biggest economies – Germany, France, and Italy – all experiencing declines in industrial production. That Germany’s economy appears to be slowing down should set off alarm bells across the region as there is no other member state whose economy is anywhere near as resilient.

Abenomics or Abegeddon?

Japan’s economic policy, known as ‘Abenomics’, is based on “three arrows”: fiscal stimulus, monetary easing, and structural reforms. Tokyo’s ultimate goal is to lift Japan’s flagging economic growth rate and the first two arrows have proven successful, but the third arrow of economic reform has yet to be shot. The sales tax hike implemented in Japan last April resulted in a weakening growth outlook for the yen and yet the unit remains well supported. The initial drop in consumer consumption when the tax was introduced has since eased, prompting the Bank of Japan (BoJ) to upgrade its view on the economy in July.

Japan’s export-driven economy requires a weaker yen to boost exports and economic growth. The short-yen trade dominated many forex portfolios in 2013 and it was expected to continue in 2014. The JPY’s(CME:JYU4) role as a safe-haven currency remains intact. Will the EUR/JPY trade force the BoJ to unleash a fresh blast of stimulus?

Further complicating matters is Japan’s quarrelsome relationship with China over territorial claims in the East China Sea. The unending dispute highlights Japan’s need for the Trans-Pacific Partnership (TPP) free-trade agreement to be ratified as a counterweight for Japan to compete with the growing economic behemoth that is China. And the TPP is tightly linked to Abe’s third arrow of economic reform.

 

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About the Author

Dean Popplewell is chief currency analyst for Oanda 

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