Forecasting the Euro to Dollar
For the last few months, I’ve predicted that the EUR to USD exchange rate would hit parity by 2017. However, things have gotten worse in Europe and I’m starting to think we may see even wider-than-expected losses in the euro to dollar.
Although this may sound a little extreme, I think it’s possible we could have an inversion of the EUR to USD, which is to say the U.S. dollar might grow more powerful than the euro. It’s entirely possible, folks, so get ready.
Recent history has revealed a very specific pattern with the euro to dollar, and we would be foolish to ignore the warning signs. All you have to do is look at the European Central Bank (ECB) to understand why the euro to dollar could crash this year.
Not only have historically low interest rates pushed some yields into negative territory, but the ECB is also buying up everything in sight. It’s buying sovereign bonds and corporate bonds to the tune of €80.0 billion per month. That’s right, €80.0 billion per month!
And when you have a central bank engaging in that level of monetary stimulus, it’s going to have some effects. Let’s say you are the CEO of a big corporation in Germany and you see the ECB start this gigantic bond-buying program. What do you do?
Obviously, you would issue some bonds to grab some of that easy money for your firm. Negative rates mean the ECB would effectively pay you to borrow their money, so heck, why not take advantage of that deal while it’s available, right?
Funny enough, that’s exactly what’s happening. Many CEOs are taking advantage of this absurdly cheap financing, but they’re not using it in the way the ECB wants them to. The entire point of lowering rates and buying bonds was to entice companies into borrowing so they could hire more people and make capital expenditures.
Those new employees could go out and spend in turn, thus fueling the next chapter of growth. The ECB was trying to engineer this demand through rate cuts and bond buying, but it doesn’t seem to be working. In the week following the ECB’s last round of stimulus, eurozone firms issued a staggering €25.0 billion in corporate debt. (Source: “ECB policy spurs corporate bond sales,” Financial Times, March 21, 2016.)
But then they spent less than we thought they would. The Purchasing Managers’ Index should have shot through the roof if those firms were using stimulus to prepare for a surge in demand, but it came in 60 basis points lower than expected. (Source: “Markit Eurozone Composite PMI®– final data,” Markit Economics web site, April 5, 2016.)
Companies simply won’t hire more people until they have enough customers to sell to; that’s the bottom line. It’s the chicken-and-egg conundrum of economics. They’ll hire when there’s more demand, but there won’t be more demand until they hire.
The ECB stimulus is going to end in failure. We can say that with almost absolute certainty, but what’s less clear is how big the fall will be. The ECB’s stimulus package was designed as a careful devaluation of the euro, a measured depreciation. But the bank didn’t account for how ineffective it would be, which is why I think the euro could crater.
Once the gross domestic product (GDP) growth numbers start slipping, my bet is the EUR to USD completely unravels.