The euro is hovering near a one year high at 1.38.
Citi FX Strategist Valentin Marinov warns clients this morning the "rally may be close to an end." He cites three reasons why the ECB is likely to reiterate a dovish view at next week's meeting, presumably sending the euro lower.
He notes a higher Euro:
- Reduces trade with top trading partners, the U.S. and China
- Tends to cap inflation (and some inflation is necessary for growth)
- Limits liquidity at a time when banks are de-leveraging.
We appreciate the reasoning, we also like Mr. Marinov's two supporting charts. First, he overlays the Citi Economic Surprise Index for the EU vs the U.S. The line has been flat for several months, meaning the EU has no appreciably better economic data than the U.S. Since this line has tended to coincide with the euro over time, he believes the current discrepancy is unsustainable. In other words, mediocre economic data in Europe cannot justify current euro strength.
Second, European banks have been weakening vs. U.S. banks. He explains this is due in part to heightened concerns about upcoming EU bank stress tests and the need for more de-leveraging. If banks are told to raise more capital, the ECB will have no choice but to maintain higher levels of liquidity via the LTRO lending facility. More Euro "printing" means currency debasement, and a lower Euro.
Clearly, both the ECB and the Fed face the same issue: Slow growth. In addition, they're also pursuing the same strategy: Policy accommodation. In a world of cross-Atlantic central bank coordination, we too agree the euro has become extended versus the dollar.