Euro/U.S. Dollar Could Decline To 1.26

Includes: FXE, UDN, UUP
by: Angelo Airaghi

The U.S. is mildly recovering, while Europe is in recession. Eur/usd could again decline to 1.26.

U.S.: Private debt is still high.

In the U.S., the combination of job and G.D.P. growth should continue for some more time. Nonetheless, the recovery remains fragile and household debt is still high. Real spending rose in the first months of this year (0.2% in January and 0.5% in February), but real disposable income declined. As a result, household saving rate fell to 4.6% to 3.7%. Why? Income growth is non-existent, wages remain low. Stocks increased, but private investor participation is limited. Finally, housing starts have climbed since last summer. However, most multi-units are not sold. They are instead rented, as households are probably still lacking the confidence to invest in the sector. Since 2009, new highs were reached only 3/5 years after prices hit the bottom (2010).

Mr. Bernanke stated nobody can be sure current improvement in the job market will last. Past history (1952/61, 1969/1982) confirms that the unemployment rate might decline short-term, but could rise again over the longer-run. Rates should stay low, until the public debt of $ 15 trillion will improve. In fact, every rate hike of 0.65% increases the debt's cost by $ 100 billion. A new stimulus package is possible, if growth starts to fade. The timing of the operation is not clear yet, since it could be seen as a direct support to Mr. Obama re-election.

German's deficit reduced.

As expected, the E.C.B. left rates unchanged last week. The central bank wants to size the effects of the various measures implemented so far. Eurogroup raised the EFSF and the ESM funds to euro 700 billion from euro 500 billion. It is just a minimum, considering euro 200 billion will be used for the bailouts of Greece, Ireland and Portugal. The rescue fund will start on July 2012, but will be fully operational in 2014. In the meantime, the Spanish finances could soon get out of control, despite the help of the 3-year LTRO program. Markets are concerned about the magnitude of 2011 budget overruns, especially in the autonomous regions. The public deficit is now 8.5% of the G.D.P., compared to the expected 6.0%. Recession is unfolding in Europe and eur/usd could decline to 1.26 again.

While the southern European states are struggling for survival, the northern countries continue with their good economic performance. The German government, as an example, was able to reduce the deficit in 2011 to euro 17 billion from euro 44 billion in 2010. The deficit should increase again in 2012, since Germany has just paid about euro 9 billion, out of a total of about euro 22 billion, for its equity contribution to the European Stability Mechanism (ESM). Germany expects the deficit to decline to 0 in 2016. However, results will depend on the strength of the economy. The president of the German Bundesbank sees high risks of heterogeneity inside the euro zone and warns about inflation rising again in Germany. Mr. Weidman is not happy with current monetary policy and few weeks ago indicated consultations on ECB's exit strategy are under way. Fiscal and structural reforms within the eurozone cannot be postponed forever.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.