Currencies: G3 -- EUR/USD Still the Path of Least Resistance
Stephen L. Jen (London)
Data in recent weeks suggest that the macroeconomic landscape of the global economy may shift in the coming months and in a direction likely to be marginally less favourable for the USD against the EUR. Although I continue to believe that the consensus view on the USD (index) is too bearish, I feel the EUR is positioned to benefit from another bout of USD bearishness. In other words, though I am not of the view that EUR/USD should rally higher, I do believe that the risks are such that, if there is another bout of USD bearishness, it will be expressed more through EUR/USD than through any other currency pair. This suggests that when the recent 1.18-1.25 range in EUR/USD is eventually broken, it will likely be the top side that is breached. However, this prospective spike in EUR/USD will be just that — a spike, not something that will last. Being deep in overvalued territory, EUR/USD will still likely trade lower over the medium term. I am not altering my view on the USD index, primarily because USD/JPY is likely to head higher at the same time.
My view on the USD remains unchanged. I continue to believe that the USD index is most likely forming a bottom, and that financeability of the US current account (C/A) deficit is not as big an issue as some people think. Having said this, there have been some changes in the macroeconomic landscape that, on the whole, are marginally less supportive for the USD against the EUR:
1. Oil prices have resurged. Oil price spikes may be positive for EUR/JPY now and somewhat negative for the USD over the medium term, if oil prices stay high. I have three thoughts on the relationship between oil prices and the USD: First, the resurgence in oil prices has so far been positive on EUR/JPY but has not really had an impact on the USD itself. Second, I believe the initial impact should be positive for the USD, as oil exporters are likely to retain a bias in favour of USD assets. Over time, however, as oil importers consume more imports from Euroland than from the US, the advantage the USD enjoys may be eroded, relative to the EUR. Third, oil price rises and interest rate hikes are substitutes in the sense that either one can help contain economic growth, but each affects the C/A very differently. Tightening through interest rates, all else equal, should help stabilise the US C/A deficit as imports are restrained. However, tightening through oil prices would lead to a further burgeoning of the US oil import bill and hence exacerbate the C/A deficit. To the extent that the US C/A deficit is already a concern for investors, high oil prices may be USD negative through this very indirect channel, particularly if oil exporters are considered to be not as ‘loyal’ USD investors as Asian exporters/central banks.
2. The US C/A deficit looks likely to widen further. In February of this year, I underscored the risk that the US C/A deficit, as a percentage of GDP, may have peaked. I was wrong on two counts. First, I had thought that the rest of the world would gradually ‘catch up’ with the US, thereby generating demand for US exports. That did not occur. Second, I did not anticipate the surge in oil prices, which further boosted the US C/A deficit. If oil prices stay high, and if the rest of the world does not keep up with the US, then the US C/A deficit could potentially widen further, toward 6.5% to 7.0% of GDP a year from now. A 7.0% print would, I fear, create an environment in which mini-stampedes on the USD could be triggered. While I firmly believe that the USD will hold its value despite the large C/A deficit, periodic speculative mini-attacks on the USD cannot be ruled out.
3. European policymakers outside the ECB appear to be adopting the bank’s view on the EUR. The latest comments by French Finance Minister Sarkozy on the EUR and oil prices suggest that at least one major Euroland Finance Ministry may have adopted the ECB’s preference for a strengthening EUR to soak up the oil price shock. Verbal intervention and any possible actual intervention may be triggered at higher levels than earlier this year, I suspect.
EUR/USD is therefore the path of least resistance. EUR is now the dominant ‘anti-dollar,’ more than at any time in the last three years. The path through the JPY will likely remain blocked, and worries over property markets should take the shine off GBP and the AUD as good ‘anti-dollars.’ In contrast, Euroland welcomes a stronger EUR. In coming months, it seems that EUR/USD could be the axis where ‘anti-dollar’ energy is most concentrated. Occasional spikes in EUR/USD are likely in response to bouts of bearishness on the USD. |
