Euro Capped by Political Worries

Currency traders aren’t focused on the long-term. Many trades last only a few minutes. But in the coming months, long-term political events are going to whipsaw trading. As the Europeans try to decide what to do now that the EU constitution has been mortally wounded by French voters, capital flows in Europe will change. And that means, volatility.

Pure and simple, the euro will be weighed down in the coming months. The uncertainty that political events have brought is not something investors and speculators like. People get nervous when they don’t know if they are about to lose money, and so they put their wealth in places where that doesn’t happen (they hope). This will be aggravated by a European Central Bank that is still trying to keep inflation in check while its main engines, the German and French economies could use a boost with lower interest rates. This means speculators will try to guess when the rate cut will come, and they will begin to discount the cut in advance.

Meanwhile, the dollar will be given an unneeded kick in the pants while the Fed raises interest rates to combat inflation. While there is nothing wrong with Fed policy in general, it is a simple case of wanting the inflation rate too low. In times of war and terrorist threats, it is wiser to run the economy a little too hot. In the event of an event by Al Qaeda, that cushion will be welcome. However, by raising US rates, dollar-denominated assets look more attractive, and that means money moves out of euros and into dollars.

Over in Asia, the Chinese renminbi and other Asian currencies remain pegged to the dollar, and as the buck rises against the euro, so will these eastern units. And if by some miracle, the Chinese and others should choose to decouple from the dollar, they will rise in value not fall. This will exaggerate their strength against the euro.

So, the euro is a screaming sell – or is it? The French have said “non” to the EU constitution, and the Dutch, who are the largest per capita contributors to the European project, will likely say “nee” on Wednesday in their referendum. But the German parliament has voted “ja!” and there are other referenda ahead where a “yes” in the local tongue will win. That will make for choppy trading. And there’s always a chance that the French might just re-work the deal and change their minds.


© Copyright 2005 by The Kensington Review, J. Myhre, Editor. No part of this publication may be reproduced without written consent.
Produced using Fedora Linux.

Home