Where Is the Euro Weakness?
Typically, when the central bank moves towards easing, the market reacts by weakening the currency. Two weeks ago, the ECB cut interest rates for the first time in this cycle. Yet the Euro remains relatively in line with the world’s reserve currency, the dollar. The question is whether the Euro can keep beating the typical trends, or will it head back towards parity again?
The argument in favor of a falling EURUSD over the coming months is that the ECB has shifted towards easing in the midst of a weak economic recovery. The Fed, on the other hand, keeps signaling that easing is not imminent, and it’s possible that it won’t get around to cutting until the end of the year. This divergence in interest rates would be expected to drive down the EURUSD. Just like it did when the Fed started hiking and the ECB stayed in easing mode, and the currency pair fell below parity.
History Is Not Repeating, Now What?
The issue is that the ECB had been making it clear for months that it would cut rates in June, so the market was really ready for that. The consensus was very solid. But now that the cut has happened, then the need to cut has gone away. Members of the ECB’s Council that make the decision on rates that up until early June were talking about the next cut aren’t so sure about it anymore. Chief among them is the Chief Economist himself, Philip Lane, who made the case for holding off on further cuts now that easing has started.
The market is starting to waver, and is no longer tracking the views of economists, who are still of a strong majority opinion that the ECB will be cutting rates at about every other meeting for the rest of the year. That means two more cuts, in September and December. This hesitancy about the ECB actually delivering on the cuts has left the Euro stronger than expected.
The US Economy Hits a Speed Bump
The other side of the equation is the Fed, which the market also expects to cut rates in September and December. But in light of weakness in the jobs market, slowing retail sales, and falling inflation, economists are worried that the economy is faltering. They say the Fed has been restrictive for too long, and is hurting needed growth.
This could be an “overcorrection” in an effort to bring down inflation, the economy might have been hurt enough so that CPI might go down to target and keep going. The Fed doesn’t want inflation to get out of hand, but it does want there to be some inflation. And if CPI falls into deflation, it could spur faster rate cuts later in the year. Particularly if GDP figures are less auspicious than currently projected. That keeps the dollar under pressure, also supporting the EURUSD.
Reaching an Inflection Point
The trend could continue for at least a couple of months as the situation becomes clear over the summer. The Fed will meet again in July, but likely won’t actually do anything until September. In the meantime, the ECB will have access to another quarter worth of economic data to see if it needs to follow through on further easing.
With the central banks saying they need more data, the market might do the same. If the ECB and the Fed do actually go through with forecasts, then they will balance out their interest rate differential. That would sideline monetary policy as a driver for the EURUSD, making the future harder to predict as the market relies more on interpretation of individual data points instead of interest rate differential.
