It does seem as if the long overdue rebalancing is coming to pass, with the Euro, which is, in any case, number two on the totem pole, likely to gain more share across the board
Boy, the market doesn’t wait around once it has made up its mind. By mid-March, when it became increasingly clear that the coronavirus was much more than anybody really understood, the volatility of EURUSD, which had been declining for so long that currency hedge funds had largely gone out of fashion, started picking up. And, it was off to the races—EURUSD volatility shot straight up, from under 5% to over 8% in less than a month.
EURUSD, not knowing what was going on, first rose sharply, then fell sharply, then hovered for a bit, and now, having made up its mind, is reaching for the skies. It appears to have lost all sense of decency and burst through a huge resistance that was set up as far back as the 2008 crisis, hitting a 2-year high at 1.1890. The next stop, at least technically, would be nearly 10 cents higher.
Will it shoot up that far? Probably. When? That, of course, is a tricky question.
With everyone and her brother on the kick-the-dollar-down bandwagon, it would seem the time is getting ripe for something of a correction, possibly a serious one.
Nonetheless, the overall direction of a weaker dollar does appear confirmed, notably by the sharp decline in real interest rates in the US. While nominal rates remain near zero, the difference between TIPS (inflation-adjusted government bonds) and the underlying securities has risen to more than 1.5%, reflecting real interest rates that are negative. The market has suddenly awakened to the reality that a budget deficit way north of a trillion dollars (and counting) has to spark inflation one way or another.
To be sure, this was also a concern right after the bailouts in 2008-09—although, at that time, the dollar rose sharply, gaining 35 big figures (EURUSD went from 1.60 to 1.25) in a matter of six months. However, the US bond yields were still “high” at around 2%, much higher than the German or Japanese bonds, and gold had been a “dead” asset for many years. There seemed no place to go, but the dollar. This trend was exacerbated by the monetary policy—Bernanke had just come in as the Fed chair, promising what he called “helicopter” money, meaning that if things got really bad, he would throw money from the skies; this hugely emboldened asset holders and managers, making the US a great place to invest.
However, the process proved hugely volatile, with several very sharp corrections in response to the multiple crises—the European sovereign bond crisis in 2011, the taper tantrum in 2015, to name two—that kept popping up from time to time. Nonetheless, the dollar strengthened over the next eight years, from nearly 1.60 to the Euro in 2008 to a low of just a bit above 104 (in late 2016).
Currently, the dollar’s newfound weakness is being reinforced by the ECB’s new ethos—finally, Europe is beginning to look like one entity, as the ECB will be issuing Europe-wide bonds to support the economy through the crisis. As a result, some pundits are calling the end of the dollar’s hegemony in currency markets. And, for the first time in a long time, the challenger is seen as the Euro and not the Chinese Yuan.
I don’t believe the dollar will be replaced any time soon—it still is used for over 80% of trade invoicing and represents more than 60% of global reserves. However, it does seem as if the long overdue rebalancing is coming to pass, with the Euro, which is, in any case, number two on the totem pole, likely to gain more share across the board.
In some ways, this also reflects the fact that—finally—Europe is being recognised as running the only truly successful model of capitalism, not just in terms of how well it has done in managing the trauma of the coronavirus, but also how it blends social support and business performance on a sustained basis. I note again that Europe has taken the lead in protecting personal information, and addressing the reality that tax avoidance and tax arbitrage are really nothing more than tax evasion (which is a crime). Further, with Germany (and the marvellous Mrs Merkel) heading the EU currently, we can be sure that the huge deficits created by the need to support the people in this difficult time will be managed sensibly.
Finally, with the strong likelihood that Trump will be summarily ejected by the US voters later this year, the trauma of America not being part of the international community will end, or at least ease. The new America will be more conciliatory, and the new world will have—thank heavens—a significant European flavour.
The author is CEO, Mecklai Financial
Views are personal