In normal circumstances the euro and the dollar move in opposite directions. As the dollar moves down against the yen or another currency, the euro strengthens against the greenback. But a curious though brief break in this relationship today illustrates the market's changing attitude toward Europe's united currency.
The dollar/yen had spent most of Tuesday's European, Asian and early New York sessions placidly consolidating above 102.90. Just before 10:45 am in New York the approach to the previous low of 102.86 generated a sharp sell-off, with new short positions probably mixed with stops accumulated in the prior hours.
The run took the dollar/yen from 102.91 to 102.80 in three minutes and was followed by choppy but steady selling down to 102.70 in the next thirty minutes. The reason for the sudden change of heart at 102.90 is less interesting than the reaction of euro traders to the faltering dollar.
The euro barely reacted to the initial 20 point fall in dollar/yen from 102.91 to 102.70, ending the 30 minutes between 10:45 am and 11:15 one point higher at 1.3735. The euro/yen absorbed the translation dropping from 141.29 at 10:42 am to 140.98 at 11:17 am. Even though the dollar has abruptly lost value against the yen, it had not lost commensurate value versus the euro.
The dollar is quoted against the yen in dollar terms but against the dollar the euro is the base currency. The euro/yen cross rate is calculated by multiplying the euro/dollar rate by the dollar/yen rate.
The impact of the dollar/yen fall switched abruptly from the euro/yen to the euro/dollar as the dollar/yen crossed the 102.70 mark at 11:14 am. From then until the 102.54 bottom in dollar/yen at 11:32 am, the euro/dollar surged from 1.3735 at 11:14 am to 1.3756 at 11:35 am. The euro/yen moved just 5 points from 141.05 at 11:14 am to 141.10 at 11:35 am.
The difference seems to have been solid buying interest in the cross at 141.00 that blocked further selling in the euro/yen.
Once the euro/yen was stabilized at 141.00, a lower dollar/yen had to produce a higher euro/dollar in order to maintain a stable euro/yen rate. What began as a dollar/yen and euro/yen move, incidental to the euro, became a stronger euro move only because the cross could proceed no lower. Traders, it seems are almost as wary of the euro as they are of the dollar.
In the currency markets these are not large moves, but the switch from a weak dollar/weak euro to a weak dollar/stronger euro mediated by the euro/yen cross is indicative of the united currency’s tenuous fundamentals. Despite a 40 point drop in the dollar against the yen, euro traders were reluctant to take it higher until forced to do so by an order floor in the euro/yen.
In recent weeks the ECB President Mario Draghi and other bank officials have strongly hinted that the bank is ready and able to institute negative deposit rates on commercial holdings in an effort to stimulate European economies. Negative interest rates in the EMU would have a similar effect on the currency markets view of the euro as the Fed’s quantitative easing policies did on the dollar.
EMU economic growth is moribund, sliding to 0.1 percent in the third quarter from 0.3 percent in the second, having just escaped the second recession since 2008. Industrial production and retail sales unexpectedly fell in October and unemployment is 12.1 percent and youth unemployment is far worse. Even German industrial output has declined for two straight months.
The strong euro, weak dollar produced by the default policies of the ECB and the Fed will be with the market until one or both of the central banks changes their mind.
Markets are waiting for the FOMC policy statement tomorrow, but even without speculation on the Fed’s intentions the bias for the euro is eroding. Although ECB officials are not likely to say so directly, a weaker euro would probably be one of the goals of a negative rate policy.
The currency market is known to be mercurial, but it may not take much of a change from the Fed to send the euro reeling.
Chief Market Strategist
WorldWideMarkets Online Trading