Euro

We may all think we are headed into the sunny uplands of growth and prosperity, but this year could see more volatility than we bargained for.

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One area of concern is governments’ monetary policies and the impact they have on foreign exchange rates. Low energy costs, low inflation and cheap imports on the back of slowing emerging market growth and the strong dollar have made us feel as if things are finally going our way. Not to pour cold water on a number of encouraging trends, but that strong dollar is already causing problems and those problems will get worse.

It’s not just exporters such as Caterpillar and Boeing that can be hurt by a stronger dollar, domestic firms also face increased competition from overseas suppliers buoyed by a lower currency. The steel industry is a case in point. Broadly speaking, for the economy as a whole there is likely to be more winners than losers but it will be highly selective and firms exposed to foreign exchange affected costs will face the biggest challenges.

Most economies will face gradual monetary tightening before the end of the decade, but the US could lead the rest of the world by at least a year. Many economists predict that as the Federal Reserve starts to raise rates in the second half of this year. Even other strongly growing economies such as the UK are not likely to join in raising central bank rates for at least a further 12 months. That will exacerbate the US dollar’s strength, particularly against economic regions like the European Union, which is embarking on quantitative easing to the tune of €60 billion per month up to a current limit of €1 trillion, but some are already predicting could reach twice that amount.

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Some countries in Europe already have negative interest rates, Denmark and Switzerland’s are at -0.5% and -0.75% respectively, charging clients for the pleasure of holding their money, in an effort to stave of safe-haven status vs the euro.

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Royal Bank of Scotland Research is not predicting base rates in euro-land or Japan to rise from 0.1% in 2015 or 2016, and in the UK they are predicted to only rise from 0.5 to 1.0% next year. That is a reflection of an almost deflationary environment and such weak growth that the risks to inflation are non-existent.

Chinese rates are predicted to fall from 6% last year to 5.6% this year and 5.3% in 2016. Likewise, India, which could fall to 7% this year from 7.8% last year, will likely only rise to 7.3% in 2016. Far from just being faced with the risk of a Greek exit, the European Union is facing exceedingly weak growth in France and Italy, the currency bloc’s second- and third-biggest economies.

Weak Growth Throughout

These are situations that would be more readily addressed by a significant loosening of policy in Germany to boost demand rather than Europe-wide quantitative easing, but that’s another matter. The risk is as much political, both Spain and Portugal have elections this year with aggressive minority parties keenly watching developments in Greece, as economic.

The EU can’t afford to allow Greece to default on its debts because it will immediately fuel demands from other quarters for the same treatment. Even France is being sanctioned by the EU for repeatedly exceeding its 3% of GDP budget deficit limits. France, too, would love to be let out of the German-led fiscal straitjacket constricting some European markets.

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After taking a 4-weak break in February, the US dollar has restarted its ascent, skyrocketing again in March. The index recently hit a new multi-year high.

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Meanwhile, the Euro has fallen to its lowest level in more than a decade. Continued friction between Greece and its EU and IMF creditors and sluggish economies are all impacting the Euro.

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We have briefly covered Greece’s decision to vote in the far left “anti-austerity” Syriza party in posts this week, mentioning the short-term impact it has had on copper and gold prices.

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In truth, though, the outcome of the election had been largely priced into both commodity prices and foreign exchange rates, so although the euro weakened on the news it has not crashed. Switzerland’s removal of the Franc’s peg to the euro had more impact and the European Central Bank’s annnouncement of a quantitative easing program was equally disruptive. But Syriza’s election and formation of the government with the help of the far-right Independent Greeks party will certainly start a period of considerable volatility in European markets as negotiations are conducted in the glare of publicity, and no doubt behind closed doors, about Greece’s future in the European single currency.

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Any failure to meet austerity commitments to the European Central Bank, International Monetary Fund and European Commission next month by Greece will see the next tranche of loans not being paid by the troika of at the end of February. As liquidity from the ECB to Greece’s banks dries up, a banking crisis will ensue.

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Not surprisingly, private money is already heading for the door, some €8 billion of deposits have been pulled since November when the election was called. So, who will blink first? Syriza or the troika?

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The new year in metals has already been marked by steep dives in commodity prices, and major changes in the status quo, so why should week three be any different?

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But this week’s story wasn’t about falling commodity prices or the price of oil and how it’s dragging its commodity brethren down. It was, instead, the week of central banking reaction and currency coming back to the fore. Sit back for MetalMiner‘s money market manipulation maelstrom.

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The Swiss franc rose 20% against the euro on Thursday, after the Swiss Central Bank announced its decision to remove the exchange rate cap against the euro. A massive rally boosting the franc occurred within seconds and liquidity dried up since, obviously, no one was going to buy euros after the announcement. This left investors and big trading firms naked as they couldn’t sell their positions until the franc was already way up. They couldn’t do anything but lose a ton of money.

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The franc also appreciated steeply against the US dollar, marking a 3-year high. Despite the strong performance of the dollar during the past few months, it seems like it will have a new competitor.

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Europe is once again in the news as a cause of fear in the financial markets. This time it’s not due to Greece or any of the Club Med countries but more due to the EU economy and the Euro as a whole.

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The value of the euro fell to its lowest level in years this week, hitting $1.19 a 15% fall from May and the lowest level since 2005, In response European stocks fell sharply amid uneasiness about whether the region is on the verge of a new economic and financial crisis.

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You can’t accuse the Germans of mincing their words, or certainly not one German economist interviewed by the Telegraph newspaper and reported in full last week. Hans-Werner Sinn, the president of Germany’s Ifo Institute for Economic Research is reported as saying the Euro-zone is doomed to a decade or more of economic stagnation and civil unrest that could destroy the single currency if countries such as France do not implement vital reforms.

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Mr. Sinn does not reserve his criticism for France but some of his words ring a bell with a view long-held in the US that the social heart of Europe is living in cloud cuckoo land when it comes to their competitive position relative to the rest of the world.

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Read the first part of this post here.  Would the US, Britain, or Japan change policy at the request of foreign powers because the foreign powers were, relatively, not doing as well? I don’t think so, especially if that meant lower support for exporters and industry, stoking inflation, and boosting internal consumption when the economy […]

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