Having touched a 5 weeks high on June 7th at 1.4696, the euro/U.S. dollar exchange rate tumbled in the following three days, falling below 1.44.
In our view, the downward trend of the euro is likely to continue in the next weeks for the following reasons:
1) The Greek debt crisis will continue to weigh on the euro as the European Union finance ministers will hardly find a definitive solution for the Greek crisis either in the June 14th special meeting of the euro area finance ministers or in the June 23rd/24th European summit. With the Greek debt that may reach 170% of GDP and interest rate payments that should rise to 10% of GDP shortly, we think that a sort of restructuring (a.k.a. default) is inevitable;
2) The monetary policy outlook may be less positive to the euro than previously expected. Indeed, the Fed's Chairman Bernanke in his speech did not signal that a QE3 program is likely in the short term even if he confirmed that rates may remain low for an "extend period." Moreover, despite having announced in the press conference of June 9th that a rate hike from 1,25% to 1.5% is a clear possibility in July, having the ECB chairman Trichet used the code word "Strong vigilance," suggested that the ECB may tighten monetary policy less than discounted by the markets. According to our calculations, the futures on the Euribor discount a 25bp rate hike in October and another 25bp rate hike in Q1 '12. However, should the economic growth weaken, as signaled by the latest economic data, the ECB may stop raising rates in October.
3) Should the decline in equity markets continue, the U.S. dollar may benefit from the flight-to-quality movements of international investors, as in the aftermath of the Lehman Brothers failure, when the euro lost almost 17%.
4) Finally the euro is 15% overvalued against the U.S. dollar, according to the OECD's PPP, a value that may trigger a correction in the exchange rate.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
