Euro Stength and the Two Charts That Matter

Mario Draghi Gets the Euro Where He Wants It – The Euro Crisis – WSJ.

Draghi Signals Euro Strength May Hurt ECB’s Recovery Efforts – Bloomberg.

ECB says will monitor impact of euro strength | Reuters.

Financial commentary has become very skewed towards divining what the utterances of the oracles of central banking mean to us mere mortals. All of the mainstream media coverage regarding the strength of the euro and its recent downtick revolves around what Draghi is saying, and no one bothers to check the fundamentals.

Even analysts are deferring more to central banks rather than examining the numbers themselves. I wrote about this trend here, Yen Weakens in Line with Fundamentals | DARECONOMICS. in terms of the recent weakness of the yen. The same analysis applies to the euro.

The euro will continue strengthening. Where it will stop depends on how much the ECB balance sheet shrinks. Outstanding LTRO’s declined €140bn from over €1trn to €873bn since banks were allowed to begin repaying them a few weeks ago. The second tranche of loans will be repaid beginning on February 28. As a show of strength, banks will repay a large sum on the first day of eligibility, shrinking the ECB’s balance sheet further:

Fed to ECB Balance Sheet

From the Wall Street Journal

Furthermore, the Fed’s balance sheet is set to grow €85bn per month for the next year or so. At that rate, the euro may even cross the $1.40 barrier.

The other chart that points to a stronger euro is the balance of trade between the eurozone and the world:

Eurozone Balance of Trade

We are on an upward trajectory here. Declining imports in the austerity racked periphery and a revival in exports among those countries and Germany will increase the trade balance over the coming months. This dynamic will cause an increase in the demand for euros raising the price as the supply decreases due to the ECB’s shrinking balance sheet.

Draghi can flap his gums all he wants, but his words will only cause a temporary respite in the euro’s rise. In order for the ECB to achieve a weaker euro, it must operate on the supply and demand of euros. This entails a monetary expansion of some kind. Currently, the Germans are completely opposed to this, and they’re the ones running the show.

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