The Amazing, Spectacular Euro

Investors are often wrong.  Professional, retail – it doesn’t matter, there is never any shortage of folks on the wrong side of a trade.  No market has confounded the professionals more in the past few years than currencies, and no currency has caused more closure of 2/20 funds than the euro.

The euro Has Been Stubbornly Range Bound (source: Bloomberg)

Hedge fund managers hate the euro.  What’s not to hate?  The crisis in the periphery, two years of economic contraction with more on the horizon, a central bank focused on the wrong outcome (remember they hiked in the Fall of 2008 in the name of inflation).  But hating the euro hasn’t paid off.

FX Manager Returns Have Been Range Bound, Too (source: Bloomberg, HFR)

Is the euro worth this scorn?  This is the continent that brought us democracy, Nutella and Dracula.  Seriously, are you going to be against Dracula?

I vant the Euro to rise – rise I command you!

Beyond the power of the undead, there are reasons why the euro isn’t falling against the dollar.  First, consider current accounts.  Our trade balance with Europe has gone from negative $5 billion to negative $10 billion over the course of the past three years.  All those dollars need to go back to euros, and that supports the currency.

We’re Sending More Dollars To Europe (source: Bloomberg, US Census)

Next, consider the central banks.  The ECB is the only major central bank tightening.  The US and Japan have been printing money, the ECB has been destroying it.  Whether you’re an Austrian or Keynsian, more money means the purchasing power of the currency declines (e.g., inflation).  Of course, we haven’t actually seen any inflation in the US or Japan (or Europe, for that matter), but this is all about forward expectations.

The ECB Continues to Buck the Trend (source: Bloomberg, Fed, ECB, BOJ)

What’s exacerbating the above to Euro support drivers is the market.  Speculators have been short the euro.  When the market is consistently on one side of a trade, it creates asymmetry to information.  Good Euro noise stops out trades, bad euro noise doesn’t attract new shorts.

At some point, the Euro should fall.  European economies are a mess, and the ECB either needs to resume printing money or risk a collapse of the union.  That could be this year, or in ten years.  Until then, there are legitimate reasons – beyond Dracula – for why the euro is sticking around 1.30 to the dollar.