I learned from my years on the “street” to buy on the rumor, sell on the news. Well, the news for weeks now has been the European Central Bank (ECB) starting its quantitative easing program and the Federal Reserve Bank of the United States possibly raising interest rates to ward off inflation and bring America out of its free-money bliss. In fact, it seems that this sentiment has become a very crowded trade, pushing the dollar to levels not seen in over a decade.
However, this is now maybe an old story and judging from the PPI data today, the conventional wisdom could very well be wrong. The numbers that came out this morning showed a decline in the Producer Price Index when the consensus estimate was for an increase of 0.3%. Of even more importance is the fact that this was the fourth monthly decline in a row. The PPI is down over the last year where economists expected a flat reading.
This means that the pressure on the Fed to act might not be as strong as the “consensus” thinks it is. In other words, the dollar could have overshot versus the euro and could be due for a correction back to earth. The PPI weak numbers are also a consequence of a strong dollar themselves; the strong dollar increases import demand and puts a lid on import prices. So, the stronger dollar is a naturally correcting mechanism against inflation.
As far as Europe and the ECB are concerned, they remain mired in a deflationary spiral. The old boogeyman of structured labor markets and state control of the economy continue to keep the continent’s economy from growing. The emperor has no clothes when it comes to Europe. The eurozone governments simply will not push through the reforms that are needed to restart growth and unlock Europe’s potential. Greece is the perfect example and there are multiple, large, critical countries in the region that are right behind Greece when it comes to irresponsibility.
As expected, the ECB’s printing money campaign to buy European sovereign bonds has ignited the EU stock markets. But traders have already anticipated the dollar’s move against the euro, hence the high valuation level of USD/EUR. Yes, the euro may fall further and breach the “parity” level and that will be a big psychological barrier; in other words, I think that’s when you back the truck up as most likely the pair will go the other way eventually.
This is all happening against a backdrop of a recovering US economy. However, I don’t think the recovery is as strong as the market thinks either. America will not start really growing until it is clear we have a more business friendly administration on its way into office. This could be almost another two years from now. The growth for the U.S. economy over the last several years has mostly been from the fracking industry which is now cooling significantly. It will take a while for this weakness to percolate through the oil patch. The problem could get even more serious if oil continues to weaken down to a $30 handle as some are forecasting.
So start looking for an entry point to take the other side of the trade in USD/EUR.
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