Keeping it simple! Euro versus the US dollar…

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Quotable

If all we talk about is money, nothing will be funny, honey And now that everyone’s a critic, it’s makin’ my mascara runny If we only talk about the heavens, makin’ it together is crazy If we don’t get a new situation for our destination we’re lazy But it’s gonna be, it’s gonna be Please make it be, it’s gonna be Now if a princess becomes human, stoner on the talk show you’re ruined Cause there’s a fine line between a skewer and a decent sense of humor…

                             It’s Gonna Be, Norah Jones

FX Trading – Keeping it simple! Euro versus the US dollar…
Winston Churchill once said: “Nowhere is more nonsense talked than by currency experts about foreign exchange.” We are in total agreement, and unfortunately guilty as charged, even though we do our best to spew a minimum of nonsense.

We believe, once all the non-sense is said and done, there really are only two key things to worry about (assuming of course you have a natural market cycle time-frame; we are not talking about short-term technical stuff that seems so popular); these two things encapsulate all the other stuff:

  1. Interest rates
  2. Economic growth

To add some nuance to these two variables:

  1. It is a relative game—an aspect that seems to allude the “dollar is going to zero” crowd who focus only on US woes (which we don’t for a minute underestimate).
  2. There are exceptions to the interest rate and economic growth rules that can last for years; especially when the ebb and flow of risk based on pure liquidity is the driver of asset prices. (Think Japanese yen here.)

That “B” part about “There are exceptions” is analogous to an economist saying “on the other hand.” Agreed! But let’s look past the exceptions at the moment and focus on the key major pair relationship: Euro – US Dollar

  1. Interest Rates – The momentum now has to shift in favor of the Fed versus the European Central Bank (ECB); that’s no surprise given the troubles facing the core Eurozone countries. The upshot: The existing front-end yield differential favoring the Euozone should disappear and go negative, already US is higher on the longer end of the curve:
  2. US yield curve (black) vs. Eurozone yield curve (red):

    US yield curve vs. Eurozone yield curve

  3. Growth – Already the numbers are showing the “relative” US growth is smoking the Eurozone countries; we expect that will continue. Keep in mind, economic growth and interest rates are tightly interwoven, any surprise growth in the US means expectations will shift even more in favor of the Fed being much more aggressive than the ECB.
  4. Euro Area GDP Growth Rate

    United States GDP Growth Rate

Source: http://www.tradingeconomics.com/default.aspx

Does this mean the euro will fall against the dollar today? No. But it does mean that over time, it sure looks as though the US dollar is poised, based on the key fundamental drivers we can define in the currency market, to rally against the euro over time.