Timeline – the Euro’s one year Rally to $1.2500
One year ago, on January 15th, 2017 – the US’s president elect, Donald Trump was in a hurry to fire the first shot in a currency war with Germany, which had just accumulated a $90-billion trade surplus with the US, in the previous 12-months. Trump threatened Bayerische Motoren Werke with a 35% import tax for foreign-built BMW cars sold in the US. He advised BMW to scrap plans to open a new plant in San Luis Potosí, Mexico and instead, urged BMW to build the factory in the US. Quoted in Germany’s Bild newspaper, Trump portrayed the EU as an instrument of German domination designed with the purpose of beating the US in global trade. For that reason, Trump said, he’s fairly indifferent to whether the EU stays together, according to Bild.
On January 31st, Trump’s top trade advisor; Peter Navarro accused Berlin of using a “grossly undervalued” Euro to “exploit the US and its EU partners.” News of the statement sent the Euro surging and the US$ tumbling. Navarro, the head of Mr Trump’s new National Trade Council, told the Financial Times the Euro was like an “implicit Deutsche Mark” whose low valuation gave Germany an exporting advantage over its main partners. The Euro is far weaker than the Deutsche Mark would have been. This means that Germany’s decision to abandon its old currency in favor of the Euro was a disguised devaluation. Imagine a Euro breakup, almost everyone would agree that the new D-mark would soar in value, making Germany much less competitive.
The comments highlighted a bold willingness by the Trump administration to antagonize EU leaders and particularly Angela Merkel, the German chancellor. Mr Trump called the EU a vehicle for Germany. In Berlin, the German Economy Ministry’s spokeswoman Tanja Alemany responded by saying; “Interest-rate expectations and the resulting impact on the exchange rate is something the German government can’t influence,” “Of course it’s obvious that a low exchange rate against the US$ makes our products cheaper abroad, which tends to boost exports.”
However, German Finance Minister Wolfgang Schaeuble could read the writing on the wall, and he told the Sueddeutsche Zeitung newspaper, the ECB should start unwinding its QE policy in 2017. “The ECB will have the tough task of getting out of the ultra-expansionary monetary policy. It would presumably be right if the ECB dared to exit this year.” Schaeuble warned that inflation could reach +3% in Germany and would inflame criticisms about negative interest rates. Schaeuble’s deputy, Jens Spahn, added, a “prudent start to the exit” of the ECB’s expansive monetary policy is desirable.
Four months later, on May 22, 2017; German Chancellor Angela Merkel declared in a speech in Berlin, “The Euro is too weak due to the ECB’s policy and with this, German goods are comparatively cheap.” Currency traders interpreted this simple statement to mean that Berlin had finally relented and gave the green light for a stronger Euro and an exit from QE.
On June 27 – ECB chief Mario Draghi opened the door to tweaking QE. “While there are still factors that are weighing on the path of inflation, at present they are mainly temporary factors that typically the central bank can look through. All the signs now point to a strengthening and broadening recovery in the Euro area. Deflationary forces have been replaced by reflationary ones,” he declared.
Oct 26, 2017 the ECB decided to keep the pace of QE steady at €60-billion /month until the end of the year, but confirming the numerous trial balloons over the previous month, it signaled a reduction of QE in half, to €30 billion /month, “starting January 2018 until the end of September 2018,” adding that this would extend “beyond, if necessary” and “until inflation path has sustain-ably adjusted.” Following this announcement, the yield on Germany’s 5-year note fell to -36-bps and the Euro fell to $1.16 versus the US$. Interest rates and the Euro fell in a knee jerk reaction to ideas that the ECB might extend QE into 2019 and beyond, because of the escape hatch the ECB had just inserted.
However, the Euro zone’s economy grew faster than expected at a +2.5% clip in Q’3 and unemployment fell to 8.9%, its lowest in almost nine years, backing up the move to begin reducing QE. Berlin stepped up the pressure on the ECB to scale back its purchases of bonds and sub-zero rates. “If we have more growth and if there is no threat of a deflation, then the ECB can slowly start to normalize monetary policy so that we can soon end this crazy situation of zero interest rates and negative interest rates,” German Finance chief Wolfgang Schaeuble said.
On Nov 21st, 2017; the man in charge of the ECB’s money-printing scheme said he expected the ECB to mothball Qe in September ’18. Benoit Coeure, the ECB director in charge of its market operations, said, “It will come at some point between now and September 2018,” Coeure said in an interview with Handelsblatt. Within 24-hours of his comments, the Euro jumped +1.5-cents to $1.200 and the yield on Germany’s 5-year note rose to -20-bps.
On Jan 12th, 2018; Bundesbank chief Jens Weidmann, one of the staunchest critics of the ECB’s ultra-easy policy, repeated his view that the central bank should be winding down its 2.55 trillion euro ($3.10 trillion) bond-buying scheme more quickly. On January 15th Ardo Hansson, Estonia’s central bank chief said the ECB shouldn’t have any problems ending its bond purchases in one swoop after September, “There are certainly good reasons to reduce the importance of the net purchases in our communication soon — also with a view to a potential end to these purchases,” he said. If growth and inflation continue to evolve broadly in line with the ECB’s latest projection, it would “certainly be conceivable and also appropriate to end the purchases after September,” he said. “The last step to zero is not a big deal anymore,” Hansson said. “You do not have to do a lot of fine-tuning. I think we can go to zero in one step without any problems.”
On January 25, 2018 US Treasury chief Steve Mnuchin caused an uproar in Davos, Switzerland when he welcomed a weaker US$, arguing that it was good for US-trade. Commerce Secretary Wilbur Ross added the, “US-troops are now coming to the ramparts” in global trade wars. His comments helped to briefly push the Euro above $1.2500; a milestone achievement for the Trump team which a year earlier; began pressuring Berlin behind the scenes for an end to QE in order to raise the exchange rate of the Euro. All that clandestine activity succeeded in lifting the Euro +20-cents higher.
The following day, on January 26, 2018; German five-year yields hit two-year highs, after the ECB’s Benoit Coeure said he saw complacency in financial markets towards inflation risks. Five-year German bond yields hit their highest level in over two years at minus -3-bps and within sight of zero percent. German long-dated yields were set for their sixth straight week of rises, their longest run of weekly increases since 2010. Germany’s Bund yield headed back towards the six-month high of 0.58%, after the ECB said it had gained confidence that inflation would rise back to its target of +2%.
The impact of the Euro’s sharp rise against the US$ was also felt in the equity markets, where the Dow Jones Industrials far outpaced the German DAX multi-nationals over the past 12-months. The Dow Industrials index is +32% higher compared to a year ago, compared to Germany DAX’s +12% gain. The stronger Euro reduces the revenues of German affiliates operating overseas, and could lead to lower German exports in the year ahead. Traders will want to see if the ECB draws a red line in the sand for the Euro at $1.2500 and whether the Fed will act to hike the fed funds rate by more than +50-bps this year.