Gross Likes Dollar vs. Euro For First Time
Kurt Brouwer July 14th, 2008
As a sign that times are changing, we take a look at currency strength of the dollar versus the Euro. This piece from Bloomberg [emphasis added] makes a strong case for a stronger dollar:
Gross Likes Dollar More Than Euro For 1st Time (Bloomberg, July 13, 2008, Gavin Finch)
…Bill Gross, manager of the world’s biggest bond fund, turned bearish on the euro for the first time since the currency’s inception in 1999.
“We might have hit a point where the euro doesn’t have a lot to stand on,” said Emanuele Ravano, co-head of European strategy in London for Gross’s Pacific Investment Management Co., which runs the $129 billion Pimco Total Return Fund. “The euro is ultimately very overvalued. It could be quite a bit lower at some point in time over the next couple of years.”
I think it is interesting that Gross was so positive on the Euro back when it first came out. By way of historical reference, the Euro fell versus the dollar for the first several years of its existence. It was not until nearly 2004 that it got back to even.
This chart from the St. Louis Federal Reserve Bank makes the point:
Source: St. Louis Federal Reserve Bank
During the recession of 2001 and the aftermath of September 11, the Fed under Chairman Greenspan cut short-term interest rates aggressively. As a result, the dollar began falling and has continued doing so.
However, nothing lasts forever. With slowing growth in Europe, interest rates are not likely to go up further. Therefore, the main prop for the Euro — higher European interest rates — will become less meaningful. The article continues:
The euro fell as much as 1.7 percent to $1.5611 in the week following President Jean-Claude Trichet’s comments on July 3 that he had “no bias” on further changes in borrowing costs after boosting the main refinancing rate to 4.25 percent from 4 percent. Before Trichet spoke the currency traded near a record high on speculation the ECB would signal more than one rate increase was needed to tame inflation. It fell 0.5 percent to $1.5857 as of noon in London today, from $1.5938 on July 11.
…As the odds that the ECB will lift rates dwindled, hedge funds sold the 15-nation common currency, according to Zurich- based UBS AG, the world’s second-biggest currency trader behind Deutsche Bank AG in Frankfurt. New York-based Lehman Brothers Holdings Inc., the fourth-largest U.S. securities firm, said it’s “increasingly confident” the euro will fall.
…The euro is 30 percent overvalued versus the dollar, based on purchasing power parity, according to Newport Beach, California-based Pimco. That’s more than any other currency among the Group of 10 richest nations. Purchasing power parity accounts for differences in the exchange rates of national currencies.
“When a currency gets between 25 percent and 30 percent overvalued it tends” to revert to the mean, said Ravano. The euro may drop to $1.535 from $1.5938 last week, he said.
...”The rally in the euro is over and we’re now incredibly bearish on the currency given the outlook for Europe’s economy,” said Hans-Guenter Redeker, the London-based global head of currency strategy at BNP Paribas SA, the most accurate foreign-exchange forecaster in a 2007 Bloomberg survey.
The euro will slide to $1.50 by the end of the third quarter and $1.45 by year-end, he said. Redeker is more bearish than most strategists. The common European currency will weaken 5.4 percent to $1.50 by year-end, and slip to $1.45 by mid-2009, according to the median of 37 analysts surveyed by Bloomberg.
“At current levels the euro is an awfully expensive currency,” said Stephen Jen, chief currency strategist at Morgan Stanley in London and a former Fed economist. “We see fair value for the currency at around $1.30.”
The Fed’s current posture is that we should not expect any additional cuts to the Fed Funds rate. And, in all likelihood, we will see higher Fed Funds rates late this year or early next year as the economy begins to pick up steam.
As a result, the dollar has shown a little strength lately. So the dollar should stabilize roughly around this level or a bit higher for a while and then we should see some strengthening when interest rates begin moving up (see Is the Euro Headed For a Fall?).
For a fuller discussion of the historical relationship between the dollar and the Euro as well as the British pound, see How Far Has the Dollar Fallen? And Why? — What’s Next?.
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Interesting article - like so many others on this site. Ironic too, given that the dollar has a low vs the Euro today. I know the daily gyrations mean nothing, but it is still a bit amusing.
Well, as I pointed out Gross was wrong about the Euro for its first several years as it declined against the dollar. So, I don’t believe he is claiming to be a prescient forecaster of currency movements. He is responding more to longer term issues because the Euro has appreciated so much versus the dollar that it is overbought. Also, he thinks EU interest rates are not going up anymore and that interest rate differential has bolstered the Euro.
Indeed. Even when bubbles burst, the falls takes days, weeks, or even months with daily fluctuations that seem to belie the longer trend. The Euro is simply over-valued, so the correction could take while and exhibit “non-corrective” behavior.
Like I said, I just found the correlation amusingly ironic (or ironically amusing).