It has been a frightening last half of October for the European common currency. After struggling in the doldrums since August, the currency seemed to find some strength after The Fed’s September meeting, which was taken as dovish by the markets, rising up to near 1.15 at its highs in the middle of October, before getting hit with a 1-2 punch these last couple of weeks. Now, it is limping into the end of the week in the 1.09 range.
The euro-dollar exchange rate is being primarily influenced by the differential between U.S. and European short-term interest rates, which themselves are being influenced by the whims of central bankers and markets that can’t make up their minds.
But in the latest foray, the European Central Bank met last week and President Mario Draghi issued a very dovish statement highlighting downside risks. The ECB also opened the door to potential additions to the amount and duration of their quantitative easing.
Then there was the U.S. Fed meeting this week, which caught markets wrong-footed in its apparent hawkishness. Almost amazingly, The Fed backpedaled on its fears of the international economy that it emphasized in September. It is true that emerging market equities have rallied a bit in the last few weeks, but many have attributed that to expectations that the Fed would remain stuck on interest rates and would continue to spur the U.S. economy.
So expectations that the ECB is leaning to the side of lower rates and the Fed is putting the December FOMC back on the table has knocked the euro down a few notches. Clearly the question now is what will happen at the end of 2015?
Our View: We see the euro as a range trade until year end. It is more or less functioning purely on how the market sees short-term interest rates moving at a particular time, and sentiment can change quickly. The Fed isn’t worried about global risks, until that changes. The Fed doesn’t see inflation, until that changes. The ECB doesn’t see economic strength, until that changes. We are soon getting to the point where our focus skips over November and December and looks ahead to 2016.
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