Hey, it’s Morgan Stanley’s idea, not ours.
Though it is an interesting way to ponder what’s going to happen when the Fed unleashes QE with two of the three other G4 central banks declining to join in. (And even the Bank of Japan’s moving to get bangs for its buck while it still can).
As Morgan Stanley’s monetary analyst Joachim Fels observes, the Bank of England is increasingly less likely to follow the Fed until next year. And the European Central Bank is even further down the tightening road.
So is this (charts via the FT/Reuters)…
Going to be as attractive next year as this?:
We’d answer a pretty blunt no, as the euro’s recent strength looks like it’s stemmed from a round of dollar weakness and a (brief) spate of sympathy for high-yielding, risky peripheral sovereign debt. Both could change very quickly as far as FX reserve managers are concerned.
Morgan Stanley is cautious too, but they do make the good point that the ECB is unlikely to resist a weak dollar in itself:
The first thing to note is that the ECB usually looks at the euro against a broad basket of currencies. On the ECB’s nominal effective exchange rate index, the euro is up 6 percent from its early summer low, but it stands slightly below its moving five-year average, and even almost 10 percent below the peak late last year. Thus, the euro would have to rise a lot further to get the ECB seriously worried…
Second, the ECB has deep-rooted aversion against embarking on large-scale purchases of government bonds… the ECB would probably resort to other tools first. One such tool would be a cut in the refi rate. Another would be sterilized or even unsterilized currency intervention. However, both are only remote possibilities at this stage.
The ECB might not be worried, but peripheral countries observing damage done to their already weak competitiveness might be, however. Especially amid a delicate period of fiscal austerity.
But speaking of European sovereign debt — there is one curious upside to the euro’s appreciation here, according to Morgan Stanley (emphasis ours):
If (a big if) this appreciation occurred because the US were seen by markets as actively trying to debase its currency in an attempt to avoid deflation and recession, the ECB might well choose to offer investors who flee from the reserve currency a new home. True, the price to pay for becoming a reserve currency is a significant loss in external competitiveness and a current account deficit reflecting the capital inflows. Yet, the benefits of offering investors a form of Ersatzgold would include higher asset prices and permanently lower interest rates, which would help especially highly indebted governments. More on this another time…
Although that was kind of the problem with peripheral bonds trading at wafer-thin spreads with German bunds for all those years, wasn’t it?
Related links:
The euro desert – FT Alphaville
Yen is envy – FT Alphaville
RIP European unsecured lending – FT Alphaville
The Swiss franc is as good as gold (literally) – FT Alphaville