The Vulnerable Euro
These are interesting times for the euro. Relative to the Canadian dollar, it may be nearing the end of its four-year uptrend (figure 1).
Figure 1: EURCAD
Figure 2 shows the most recent Wall Street forecasts for 2019 exchange rates. Despite the great unknown of what happens when European Central Bank (ECB) president Mario Draghi passes the sceptre to Christine Lagarde this winter, the median estimate for EURCAD is a miniscule weakening of the loonie from C$1.484 to C$1.49 at year-end.
Figure 2: Street Consensus, EURCAD
Meantime, the backdrop is a total currency war, with Canada among the weakest of the fighters, which is a good thing for CAD bulls. Like the Bank of Canada, the Federal Reserve is—by comparison with many other central banks—fighting the currency war meekly. The U.S. central bank’s balance sheet has declined from US$4.5 trillion to US$3.8 trillion in about four years. But at the ECB and the Bank of Japan (BoJ), crisis-style quantitative easing is at the top of the rumour mill.
And though the Fed may not be fighting hard in the currency war, Washington makes up for it. President Trump is clearly jawboning for a weak dollar. There’s also the matter of the federal fiscal situation in the world’s largest economy, which doesn’t matter until it matters. The U.S. budget deficit-to-GDP ratio of 4.3% is the reddest ink in the G10. In sharp contrast, the Street forecast for Ottawa is for roughly balanced budgets as far as the eye can see.
We could almost understand the “need” for currency wars 5 or 10 years ago, but today, with the S&P 500 Index just off recent highs of around 3,000? Hardly. Yet almost every country is fighting this war, with the arguable exception of Canada, sitting here with a largely responsible budget and a central bank that may do nothing this year.
Which is why this saga’s possible next chapter, which would be positive for equities and negative for the euro, is particularly surreal: the ECB purchasing stocks.
It took less than a generation to balloon the ECB’s balance sheet from below €1 trillion (C$1.48 trillion) to €4.67 trillion (C$6.93 trillion) via bond purchases. How big of a dent can the ECB make in equities? This isn’t the C$32.8 trillion S&P 500; the MSCI EMU (European Economic and Monetary Union) Index is only worth one-sixth of that.
Did you know the Swiss National Bank had 20% of its reserves in global equities in Q1? Russia is on a similar wavelength, though its taste is for gold; that hoard is up to US$100 billion (C$132 billion) from US$50 billion (C$66 billion) four years ago. Washington placed sanctions on Moscow, so Moscow diversified. Trying to figure out how the metal got to US$1,500 an ounce? China is accumulating too.
It’s not just a handful of players that have gone rogue in the once staid world of central banking. South Africa and Israel have also played the something-other-than-bonds game in recent years. Don’t leave out the mad scientist of central bank experimentation. The BoJ has been buying equity ETFs for a half-decade. Its published guidance from last summer was for ¥5.7 trillion of yearly purchases. That equates to €47 billion. If the ECB plays Simple Simon, it buys 1% of European stocks each year.
If we see several years of this, guess who becomes the dominant owner of equity capital? Ah, control of the means of production by an unelected, opaque, centralized power. Good idea.
Lucky for us, such critical mass is still years into the future. This looks like a “don’t fight the Fed” situation, only this time “the Fed” is actually the ECB. Both USD and CAD stand to benefit relative to EUR, while global equities in general have a new buyer.
Unless otherwise stated, data source is Bloomberg, as of 8/8/19.