Euro speculation
What will become of the euro? There has been all kinds of speculation with regard to the euro's exchange rate starting last year when the ECB aggressively opted for new monetary measures such as negative interest rates, additional programs of quantitative easing and asset purchases.
In addition to those measures the ECB even actively sold euro and bought dollars. This was something that many thought would never happen. The feeling was the ECB would never want to give the impression that the euro was somehow "backed" by the dollar.
A period of euro stability has emerged
Until recently the euro traded down to a level that successfully correlated to higher export sales and profits for large European firms, particularly German firms. We saw this in their numbers and in various quarterly profit data.
Record exports and profits were a signal that the price discounting that had taken place was over at least for the time being. The euro established a new equilibrium level between 1.04 dollar and 1.15 dollar. Yet there wee still predictions of euro/dollar parity despite the euro's new found stability.
The "euro" printing by the ECB was never euro printing at all, although many market participants believed it was. All QE is, is an asset swap. It's an exchange of euro denominated securities for euro denominated reserve balances. There was no, net money printing of any kind. Nor was bank lending increasing by much. This is largely misunderstood not just by market participants, but economists as well.
Price setting by exporters drove the euro down
Primarily, what drove the euro lower was price setting by large firms. By price setting I mean price cuts. Over time exchange rates tend to adjust and reflect these price cuts. In the euro's case when price cuts reached a point where export sales (and profits) started to surge; there was no longer a need for those price cuts. Thus the euro's exchange rates stabilized.
That lasted for a while, however, several weeks ago the Chinese lowered the foreign exchange rate of their currency, the yuan. Not only was this deflationary--and we saw this almost immediately with selloffs in commodity markets, particularly oil--but it represents a new source of competitive price pressure for German firms and other euro denominated exporters.
Is a new down leg about to start?
This suggests that we are on the verge of a new leg down in the euro; one that could take us to the old lows of around 1.04 to the dollar or beyond.
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