Tags: euro | employment | dollar | ECB

The Downward Path of the Euro Is Definitively Drawn

Tuesday, 08 July 2014 01:28 PM Current | Bio | Archive

Every month, on the Monday after the Bureau of Labor Statistics releases the U.S. employment situation data, we get the monthly Employment Trends Index from The Conference Board, which is a private global, independent business membership and research association working in the public interest.

Well, when the employment situation data of those two entities — one public and one private — give indications that point in the same directions there is a good probability we are witnessing the formation or confirmation of a trend.

However, there are still a lot of people who remain skeptical about the soundness of the job numbers, particularly since the labor force participation rate remains at a far-too-low 62.8 percent, the same as where it stood in March 1978 (!) and well below where it stood when the "Great recession" started in January 2008 and the official end of the recession. Also, the U-6 rate, which is the total unemployed plus all marginally attached workers and those employed part time for economic reasons, at 12.1 percent in June remains too high.

The good news is that like most other employment-related data, things are continuously moving in the better direction.

And the good news is confirmed by The Conference Board's Employment Trends Index, which is up 6.3 percent from a year ago and now stands at 119.2, while increasing rapidly in recent months. This suggests strong job growth is likely to continue through the summer.

Of course, the average productivity of workers will also need to rise at a faster rate than in the first quarter, when productivity only increased 1 percent year-over-year and output and hours worked rose 2.8 percent and 1.7 percent, respectively. Without increasing productivity it's practically impossible to have a solid and sustainable recovery. So, productivity performance should remain on our radar screen.

All that being said, one must admit the U.S. unemployment rate, which now stands at 6.1 percent, is much better than what we see in the euro area, where the unemployment rate is 11.6 percent, although it is down 0.4 percent from 12 percent a year ago.

In case the United States remains on this path to recovery and continues as it is performing now, there is no doubt whatsoever in my mind that we will finally see, and maybe earlier than many think today is possible, the Federal Reserve starting to raise (normalize) rates within the next 12 to 18 months.

At the end of last week, we witnessed sharp movements in the Globex Fed Funds futures complex, with the September 2015 contract now implying about a 25 basis points (bp) rate hike by the end of the third quarter of 2015 and with the December 2015 contract another 25 bp hike by the end of 2015.

I'd like to add here there is a very low probability the euro will maintain within its actual exchange rate trading range against the dollar once and even before the Fed funds rates will start rising in 2015.

It would be worthwhile to take notice when contemplating real-money flows as observed in New York, the outflows out of the dollar literally have dried up since around June 12, while at the same time the euro has remained very firmly out of favor, as in fact has been the case for both currencies since May.

For what it's worth, data from the Commodity Futures Trading Commission show that since early May speculative players have been net sellers of euros, but please take care, these euro short positions still remain relatively small compared with where they stood two years ago.

Besides, when last Thursday European Central Bank (ECB) President Mario Draghi at his press conference answering the question if the ECB would envisage taking any further measure to try and weaken the exchange rate of the euro he stated: "To some extent, there are many factors that influence the exchange rate, and I don't want to dwell on each one of them. Certainly, the weakness of the European economy, the very low rate of inflation, the extremely low levels of interest rates, do have an effect on the exchange rate, which isn't . . . if you look at the four months ago, it was higher, way higher than it is today. But it's a problem. It is, indeed, because as I say, it affects our objective of price stability."

In clear English, Draghi said he thinks the euro should be lower. I'd like to add here that Draghi was prudent enough not to give the slightest hint the euro could actually become a funding currency (carry trade) relative to the dollar. Nevertheless, I think there is really a big chance it will, in the foreseeable future, at the latest when the Fed funds finally will start normalizing.

Now, it must be said Draghi is not alone and in the context of what he "probably" was thinking at his press conference, Fabrice Bregier, CEO of Airbus' passenger jet business, commented in the Financial Times: "The ECB should intervene and lower the value of the euro by 10 percent from an 'excessive' $1.35 per euro to between $1.20 and $1.25 . . . we just have to go back to more normal exchange rates. . . . We just have to give long-term visibility to the markets that this is now a key political willingness of the European nations."

Many long-term investors still struggle with the question why the euro has maintained its relatively "high" levels compared with the dollar, even though the euro area remains plagued with very slow growth and important parts of the eurozone are close to stagnation, very low inflation and way too high unemployment, especially among the younger people.

Now that Draghi made it clear that the ECB still can do more (easing) policy, and over the weekend ECB Executive Board Member Benoit Coeure said the ECB policy rate will remain very low for a long period of time (whatever other central banks like the Fed will be obliged to do), the downward path of the euro seems to me definitively drawn and there is a great chance we could witness the birth of the euro's attractiveness for becoming the new important funding currency in the foreseeable future.

Yes, long-term investors would do well taking notice of this, at least in my opinion, important fundamental change in the foreign exchange world.

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The downward path of the euro seems to me definitively drawn and there is a great chance we could witness the birth of the euro's attractiveness for becoming the new important funding currency in the foreseeable future.
euro, employment, dollar, ECB
Tuesday, 08 July 2014 01:28 PM
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