Rate Differentials Getting Traction

Includes: FXE
by: Marc Chandler


There is divergence in trajectory of US and Europe short-term interest rates.

They de-coupled for most of Q1.

Now the dollar is finding better traction.

This Great Graphic is the bane of our euro bearishness, at least until last week's FOMC meeting. This Bloomberg chart shows the US premium over Germany on 2-year money (white line) and the inverted euro (yellow line).

We have often found the spread helpful thinking about the euro's movement. You can see how well the differential tracked the euro-dollar exchange rate until more recently and especially since February.

However, the divergence of monetary policy is reaching a point now that indeed seems to be re-coupling the two time series. Although most Fed watchers still expected the first hike in H2 15, there is clearly risk that it comes earlier. At the same time, many do not think the ECB will move next week, but recognize the risks have increased by the low CPI readings in Germany, Spain and Belgium. Money supply growth remains lackluster and private sector (non-financial) lending continues to contract. Excess liquidity in the euro system is threatening to fall below 100 bln. EONIA has not spiked (yet) into month and quarter end, but around 17 bp, it is twice the US equivalent (effective Fed funds).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.