It's a simple trade, really, as two things work in tandem to bring the euro down. Both a reduced growth projection as well as an escalating European sovereign debt crisis are forcing a more expansionary monetary policy on the ECB. The euro will fall as a result and the market is only beginning to price this in.
Until recently, growth in most of the euro area was firm and the danger of inflation creeping up all too real. In response, the European Central Bank (ECB) hiked interest rates twice to 1.5%, moves they'll probably regret by now.
This is because Q2 growth figures from the core countries really disappointed. In essence, growth came to a screeching halt and with confidence shaken on many levels (US, debt crisis, etc.), prospects for a quick revival of economic growth are bleak, to say the least.
More important still, uncertainty about the European sovereign debt crisis is increasing as we write. Consider the following quote from the usually very well informed Evans-Pritchard from the UK Telegraph, to get some flavor of what is going on in Europe right now:
First we learn from planted leaks that Germany is activating "Plan B", telling banks and insurance companies to prepare for 50pc haircuts on Greek debt; then that Germany is “studying” options that include Greece's return to the drachma. [UK Telegraph]
On Friday, Jurgen Stark resigned from the ECB. This is the second 'hard money' German after Axel Weber (once the favourite to succeed Trichet at the helm of the ECB).
With 'hard money' Germans leaving, and Trichet already signaling the increased risks to the European economy (read: no more interest rate hikes), the whole monetary policy picture is changing for the euro, even under 'normal' circumstances.
But these are not 'normal' circumstances we're living under. European politicians have really demonstrated ineptness in dealing with the sovereign debt crisis. Potential solutions like an increased rescue fund (the EFSF) or the issue of eurobonds are not coming any time soon.
In the meantime, it's the ECB that has to deal with the immediate crisis on the financial markets (and in the banking system). It's program to buy up Italian (and Spanish) bonds and provide liquidity to the European banking system are the rocks what keeps the euro area together.
And then there are so many banana peels, ways in which the European sovereign debt crisis can escalate, which offer the possibility of the euro lurching sharply downward should the crisis escalate.
With 'hard money' Germans deserting the ECB, European growth prospects declining fast, European politicians not delivering and an escalating European sovereign debt crisis there is only one direction that ECB monetary policy can go, and that is in a much more expansionary direction. This will take the euro down further.
Disclosure: I'm short euro
