By: DAVID JOHNSON
David is a Director of Halo Financial Lt, a company which provides exceptional exchange rates and foreign exchange information for currency transactions involving migration and overseas property investment as well as services to companies involved in international trade.
EINSTEIN WOULD have loved the currency market; it is all cause, effect and relativity.
Sometimes the reasons for exchange rate movements are very obvious; it’s just a matter of following the cause and effect. July 3 was a perfect example. European interest rates were expected to be hiked by 25 basis points, the European Central Bank did as expected and the Euro strengthened because by lifting the EU base rate to 4.25 per cent, the ECB increased the attractiveness of EU interest rate yields relative to other currencies like, perhaps, the Swiss Franc where 2.75 per cent is the average rate or the Japanese Yen where the base rate is just 0.5 per cent.
Simple calculations of cause and effect make successful currency buying and selling decisions an absolute doddle. However, the Euro immediately gave up those gains as short term traders took profit once the ECB made it very clear they were highly unlikely to hike EU interest rate any further in the months ahead. Again, the cause and effect is a clear path and, as long as they have access to reliable and timely market information, anyone with Euros to exchange or buy would be able to make an astute decision.
Things get a tad more complicated when you see just how precisely the Euro’s strength aligns with that of crude oil. As a major importer of oil and energy products, the Eurozone should be vulnerable to higher oil prices and therefore, following the principles of cause and effect, higher energy prices ought to lead to a weaker Euro. No one could argue with the logic except this is precisely the opposite of the effect we are seeing. In the current market, as the price of crude oil rises, up goes the Euro’s strength and vice versa.
This is still a cause and effect issue but the path is a tad more convoluted and, as with so many things in global affairs, it involves ‘consumption central’ or America as it is more commonly known. The fact is that America is a greater importer of energy products and with the US economy further down the line into the global slowdown than Europe, the impact of higher energy prices is felt more severely in the US than in the Eurozone. I am sure you would argue that point vehemently every time you fill your car up but in macroeconomics terms, it is true honestly. So the cause and effect follows this path, the oil price rises, international investors anticipate the negative effect on the US economy and sell the US Dollar and what is the next best reserve currency to the US Dollar? Well it is one of the youngest currencies in circulation, the Euro.
Consequently, US Dollar weakness leads to Euro strength and the correlation between higher energy prices and a stronger Euro is entrenched…for the moment.
Undoubtedly, the Eurozone will see further fallout from the US economic problems. The disastrous fall of 45 per cent in the stock market values of Fannie Mae and Freddie Mac, America’s largest mortgage funding instruments involved in 50 per cent of all US mortgages, may well have repercussions on this side of the Atlantic, and the US Treasury’s decision to support these funds in their current form might prove to be a temporary fix for a longer term problem. The consequence could be a change in the alignment between the Euro and the price of oil which could well dissipate over time but I return to the comment I made earlier that with the right access to reliable and timely market information, it is possible to be on top of these changes as they happen, rather than being penalised for not knowing about altered perceptions and patterns until it is too late to take advantage.
If E=MC2 works for physicists then S=IT (Savings = Information x Timing) is surely one of the most important formulae for currency traders.