Update: Euro Dynamics – Stocks, Yield, Currency
14 May 2015/6:21 a.m. ET
We are seeing a dynamic relationship between German stocks, 2-year benchmark interest rates, and the currency—EUR/USD. The rise in short rates coincided nicely with a sell-off in stocks and a rise in the euro as you can see in the chart below:
This is not what ECB Governor Draghi had in mind when with quantitative easing. In fact, rising rates and a strong euro counters the effectiveness of QE and likely leads to portfolio flow from international stock funds out of the Eurozone—the real economy in Europe needs rising stocks as rising stocks are a huge repository of collateral value; that is the direct feed-back loop to the real economy.
Portfolio flow out of European stocks, money that was most likely hedged, i.e. short euro and long the US dollar, leads to the dynamic of pushing EUR/USD higher as the hedge is removed.
So, the key driver seems the 2-year benchmark yield—the blue line in the chart above (which given the recent relative juxtaposition of disappointing US economic news versus improving Eurozone news makes some sense at least relatively). What I am looking for is a corrective top in euro in the 1.1450-1.1532 level. We are close. I am looking for yield confirmation from Europe; but we have to consider the risk of continued relative US economic weakness could lead to some type of blow-off move in EUR/USD; ultimately planting the seeds of its own destruction, hyperbolically speaking. Stay tuned.