EURO-DOLLAR TRADE IS AN UGLY CONTEST

DIRECTOR OF CURRENCY RESEARCH, GFT

LET’S just retrace Tuesday’s euro-dollar price movements. First, the pair rallied in early Asian trade when a Wall Street Journal article reported that the Fed is considering a quasi-permanent QE policy, raising fears that the central bank will eventually monetise more than a trillion worth of US debt.

Then, before anyone had a chance to take a breath, the pair tumbled on rumours that Moody’s would soon downgrade Spain’s AAA rating by possibly two notches. After consolidating for less than an hour at $1.3400, the euro once again raced back to $1.3500 as an ex-Chinese central bank advisor Yu Yongding said China is worried about the safety of the dollar, only to fall once again after chancellor Merkel said that Germany would not agree to an extension of Eurozone rescue measures.

Confused? You are not alone. In the euro-dollar trade, market sentiment quickly lurches from shunning one currency to despising the other. Yet away from the intra-day noise it is important to understand that trade in the pair is driven by two competing considerations. On the one hand the market is worried about sovereign debt issues in Europe and the chance that the union could fragment if Greece and Ireland are unable to restructure their debts. On the other, the threat of never-ending QE raises the spectre of serious dilution for the dollar and the possibility of high inflation as foreign buyers reduce demand for US debt, forcing the Fed to hike rates to attract capital.

At present the market appears to be less concerned with the sovereign debt fears in the Eurozone than the dilutive prospects of the Fed’s QE2 program. Still, it is difficult to determine how this scenario will resolve itself. Therefore I prefer to sidestep the whole affair for now and focus on other currencies such as the Swiss franc and the Australian dollar. After all, there is a reason why euro-dollar trade has been dubbed the “ugly contest”.

Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read commentary at www.GFTUK.com/commentary or e-mail borisandkathy@gftuk.com.