As long as the political will to pursue the European project exists, and it does, then the EU and euro cannot fail.
This is not to say there have not been wild swings in EUR/USD — there have been. You can see them in the chart below.
The EUR/USD cross-rate has experienced six separate swings averaging 21.3% each in the past ten years.
What’s important to understand about these swings is that they are mostly manipulations of the exchange rate by the two responsible central banks — the Fed and the ECB. The 21% decline in the euro in 2008 was mostly a flight to quality during the global financial crisis. The Fed gave trillions of dollars to the ECB in the form of hidden currency swaps in order to bring the euro back to life.
The 19% rally in the euro in 2009 was part of the Fed’s weak dollar policy designed to help U.S. exports and bring the U.S. economy back to life after the crisis. This was orchestrated by the two central banks and marked the beginning of the new “currency war” that roiled emerging markets.
And so it goes, back and forth, back and forth.
The other important fact to understand about the euro and the dollar is that they’re currencies, not stocks or bonds. A stock can go to zero if a company files for bankruptcy. A bond can go to zero if the borrower defaults. But, major currencies don’t go to zero, they just fluctuate in a cross-rate relationship.
Since 2000, the euro has traded in a wide range, from $0.80 to $1.60, but most of the action has been in a tighter band of $1.05 to $1.45. The euro bounced off the low end of the range for the third time in late 2016, and is now headed decisively higher.
Based on these continual 20% swings in EUR/USD, what’s next for the euro?
The most important signal is that the anti-euro nationalist political tide in Europe seems to have crested. After some close electoral calls in the Netherlands with Geert Wilders and in France with Marine Le Pen, the pro-euro parties emerged victorious.
In particular, the election of Emmanuel Macron as President of France has given the euro new life since he is both pro-euro and is enthusiastic about working with Chancellor Angela Merkel in Germany to make EU institutions stronger than ever.
Merkel is well on her way to another victory in the German elections on September 24. Merkel is the most powerful leader to emerge in Europe since the 1970s of Margaret Thatcher or the 1960s of Charles De Gaulle. Merkel’s answer to the critics of the EU and euro project is not disintegration but “More Europe.”
That is exactly how she and Macron of France intend to proceed.
Finally, and most importantly, the two dominant central banks, the Fed and ECB, are ready to coordinate their currency moves once again. For the seventh time since 2008, the two central banks are ready to orchestrate a move of 20% or more in the EUR/USD exchange rate. This time the move will be in favor of the euro as it was in 2009 and 2011.
The Fed has been engaged in tightening monetary policy since the “taper talk” in May 2013. This tightening has proceeded through the actual taper (December 2013 to November 2015), the end of “forward guidance” (March 2015), the “liftoff” in interest rates (December 2015), and three additional rate hikes (December 2016, March 2017, and June 2017).
The problem for the Fed is that they have tightened into economic weakness and have come close to throwing the U.S. economy into a recession. The Fed will now “pause” in their interest rate hikes and return to “forward guidance” with respect to future rate hikes and balance sheet normalization. This easing will weaken the dollar.
At the same time, the ECB is emerging from a long period of ease and is just beginning its tightening phase. The ECB is about four years behind the Fed in this process. While the Fed started its taper in December 2013, the ECB will begin to taper around September 2017.
Once the ECB finishes the taper of bond purchases, probably in mid-2018, it will then move slowly toward interest rate hikes. This tightening phase will strengthen the euro.
In the currency wars, the combination of dollar easing and euro tightening will send EUR/USD soaring.
Based on past swings in the EUR/USD cross-rate, I expect the euro to go from $1.17 to $1.25 by year-end and to $1.30 or higher in early-to-mid 2018.
This decisive move would be the seventh since 2008, and suggests just how volatile currency markets have become.
Regards,