Consider what happened to euro/dollar. On July 24, just six weeks ago, it hit a low of 1.20 dollars per euro. On Friday morning, the euro passed 1.31 dollars. There is no big mystery about what produced this rally:
- The ECB promised conditional unlimited bond buying. For those that think this is money printing, the ECB will sterilize (that is, offset the monetary effects) of these purchases to make them monetary neutral. But even if it would not, this is, according to many, the proverbial 'big bazooka' that could defuse the eurozone crisis flaring up for quite some time, time that the politicians should use wisely to defuse the crisis for good.
- The German Constitutional Court didn't shoot down the EMS, the permanent European rescue fund.
- On the same day, the Dutch didn't vote for strong anti-euro parties in large numbers (which was quite a surprise considering the polls from up until a week before the elections).
- The Fed delivered on more monetary easing.
All this was good for 10+ dollar cents per euro. It could very well be that there will be another couple of cents added, but we don't expect it to last. We've already explained some reasons for that, like the weakness of France and its unwillingness to reform.
But the euro rally itself is simply quite bad and will dampen growth in the euro area further. It is somewhat ironic even. The eurozone desperately needs some form of impetus to restore growth. The only market-based solution to this was a weaker euro, and the euro was weakening until the ECB shifted policy that took away some downside risk for the eurocrisis imploding. But that has lifted the euro nearly 10%.
Can the eurozone handle a higher euro, with much of it marred in deep recession or even depression? A closer look at the figures is warranted. One could argue that the eurozone as a whole doesn't have a competitiveness problem since the eurozone as a whole has a pretty substantial and growing trade surplus.
However, one has to take into consideration that many eurozone economies are quite depressed, which artificially lowers imports. Any economic recovery would worsen the trade balance.
More importantly, considering intra- and extra-eurozone trade developments for the months where the euro was still falling, Rebecca Wilder from FTAlphaville concluded:
I conclude that it's the depreciation of the real exchange - the 12.7% nominal depreciation of the euro against the dollar, for example, and/or falling relative price levels with extra-EA economies - that's the primary driver of the improving trade balances in key periphery markets. With the strong exception of Portugal, where the intra-EA balance improved by 2.6 ppt of GDP over the year, the internal (infernal) devaluation of repressing wages through high unemployment has mixed results at best.
Well, that depreciation has now been almost completely undone! Another thing to notice is that besides Portugal and Greece (and to a lesser extent France), few countries seem to have an intra-eurozone trade problem.
The positions of Italy and Spain are encouraging, although one has to keep in mind both the Spanish and Italian economies are in deep recession, which makes their trade figures look better. The French intra-eurozone trade worsening confirms the our reading of the French economy as the next potential eurozone trouble spot.
Note also that Germany has an intra-euro surplus, but a minuscule one. It doesn't seem to have the enormous competitiveness problems often ascribed to it (including by us, we have to note). The real 'mercantilistic intra-eurozone trade villain' is the Netherlands with a really stunning 25% of GDP intra-eurozone trade surplus. Extraordinary.
For fun, the picture is quite different if one considers the extra-eurozone trade figures. Ireland is still very competitive. Germany's performance is also a lot stronger, but for the Netherlands there is a really curious reversal. From a 25% intra-eurozone trade surplus, the country does particularly poorly trading with countries outside the eurozone. Much worse than either Spain, Italy, Greece, or Portugal, as it happens. Who would have guessed..
But, the quick reversal of the euro isn't at all helpful for any in the eurozone. The Fed, while acting on weak domestic demand in the US, isn't helpful here. Hopefully some of the price effects will be offset by volume effects; that is insofar as US domestic demand will increase as a result of Fed policy, this will also boost demand for European goods and services. But don't hold your breath. The Fed effect on domestic demand is likely to be quite weak.
We think the strengthening in the euro will soon run into trouble on the next episode of the eurocrisis, and the time is nearing to short the euro ETF (FXE).