Over the past month, the euro has substantially strengthened against most other currencies. In a move which has largely been attributed to a resurgence of the economy and quantitative easing, the euro has surged by nearly 3% - which is quite significant for a major currency across this timeframe.
Over the last 3 months, we have experienced the largest appreciation in the euro since the dual forces of a double-dip recession coupled with U.S. quantitative easing drove it to a multi-month low. You see, this movement is more than significant for its magnitude, but also for what it represents. Since the global financial crisis the European Union has struggled with persistently low inflation, high unemployment, and even bouts of civil unrest in some regions. These factors are not good for a currency. As an economy slows, foreign investment capital leaves an economy. As investment capital leaves a region, demand for the currency falters and the currency tends to weaken. Additionally, central banks stimulate the economy through jawboning or direct market intervention with the primary purpose of weakening a currency. If a currency becomes cheap enough, then exports tend to rise, business picks up, and capital enters a nation once again.
As I noted at the beginning of the month, the European Central Bank has been aggressively pursuing an agenda to stimulate the economy through quantitative easing. Despite popular beliefs, quantitative easing can strengthen a currency in that as the prospects of an economy improve, foreign investors move capital into the economy to take part in the resumption of business. This is what we have witnessed in the Eurozone this year. In fact, it is just reported that inflation is increasing at the strongest pace witnessed since 2012.
What is most ironic about this rally is the short term memory of market participants. Less than two months ago, pundits were nearly screaming to sell the euro due to an imminent breakup. Despite this call, the euro remains and continues a strong recovery. The icing on the cake is that now the euro is being hailed as a potential safe haven in a world gone awry. My how fickle we humans can be! The lessons here are simple and straightforward: ignore the consensus view. When everyone says that you should sell and yet price continues to rise, everyone is going to be wrong and must cover their positions. In other words, it pays to be a contrarian. As I write this, the average retail investor and trader is short the euro and losing lots of money - eventually these traders will be required to sell at a loss, further propelling the current rally. Traders are buying the story that the disintegration of the euro is still a possibility (despite a clear mandate from every nation to preserve peace).
As an investor, there are few factors necessary for success. First and foremost, you need a fundamental understanding of the market in which you transact. Secondly, you must understand what others know. It is only through exploiting the interaction between the facts and the market's perception of the facts that you can earn profits. You see, following common wisdom and media headlines in financial markets is a surefire way to lose money. Presently, the world still believes that the European Union is in for trouble with:
- High, double digit unemployment, which leads to economic suffering and civil unrest.
- An aging population and difficult business laws, which weaken the elasticity of the economy during times of turbulence.
- A monetary union without central governance to ensure the cooperation of all members.
- The list could go on and on.
And yet, despite these facts, the euro remains and continues to strengthen and respond to simulative actions. The common error I have observed in pundits as they evaluate the facts is that they do not account for the very real possibility that facts change. Sure, unemployment is high, but the ECB has a mandate to do whatever it takes to improve unemployment, and that's exactly what it's doing. Sure the population is aging and there are difficult business laws, but nations are allowing immigration at accelerated rates and making bailouts hinge upon economic reforms. It seldom pays to take a glance at the present circumstances and make an investment decision based on what you see. In fact, over the last 6 months, large speculative trading houses have purchased over 25 billion euros and almost entirely eliminated a net short position. These guys only make money by being correct in their calls. Some of these funds even hire former central bankers to give them advice on what other central bankers are about to do. In other words, it makes a lot of sense to pay attention to what these funds do, and right now, they are buying the euro rampantly. The nimble investor would be wise to do the same.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in EUR/USD over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Working orders to purchase the euro against a basket of other currencies