Texan Discovers Key to Euro Going Against Consensus: CurrenciesJohn Detrixhe
If you want to know where the euro is headed, look to Texas.
That’s the home of Prestige Economics LLC, the fewer-than-10-person researcher and consultancy that proved to be the most-accurate forecaster of the euro-dollar pair last quarter among more than 50 firms worldwide in data compiled by Bloomberg that considered the average of the past four periods. Prestige was also No. 1 for the pound-dollar and dollar-Swiss franc, while coming in at No. 2 for euro-yen.
The 18-nation euro has confounded most all prognosticators in recent years, rising to its highest level since 2011 in the face of predictions that it would crumble as the region struggled with a sovereign-debt crisis and recession. While the consensus is sticking to its call for a weaker euro, Austin-based Prestige and its 37-year-old founder and president, Jason Schenker, say more gains lie ahead.
“I’ve had an out-of-consensus view on euro strengthening, and I still have that view,” Schenker, a former consultant in Germany for McKinsey & Co., said April 4 in a phone interview from Houston. He reiterated his views in a call this week.
What most forecasters fail to take into account is the European Central Bank’s tolerance for below-target inflation because of the region’s history with hyper-inflation, Schenker said. That lessens the odds that the ECB, unlike the U.S. Federal Reserve, will move to spark inflation with policies such as printing money to buy bonds, thus debasing the euro.
Another reason European policy makers won’t let inflation accelerate too quickly is that it would damage the value of fixed-income assets, said Schenker. Unlike the U.S., the euro area favors debt over equity, and the resulting fallout could hurt investments and growth, he said.
“On the continent, there’s a really heavy mix of fixed-income investing versus equities,” said Schenker, who was raised in Somerset, Massachusetts. “That’s supportive of their inflation hawkishness.”
Schenker called for the euro to climb 1 percent to $1.39 in the first quarter from $1.3743 at the end of December, compared with a median estimate for a drop to $1.32, Bloomberg data show. Europe’s common currency closed at $1.3769 on March 31, before trading at $1.3892 as of 2:48 p.m. in New York.
That gave Prestige a Bloomberg Rankings score of 91.78 out of 100 based on margin of error, timing and directional accuracy. Australia & New Zealand Banking Group, which according to data compiled by Bloomberg has 47,512 employees and a market capitalization of about $88 billion, was second with 88.27.
Final scores for each currency pair in the rankings are the time-weighted average of the four quarters that ended on March 31.
“For many people, the euro proved to be quite a bit stronger than expected in the first quarter,” said Shaun Osborne, chief currency strategist at Toronto-Dominion Bank.
The firm sees the euro weakening to $1.22 by year-end, Bloomberg data show. The estimate is based on Europe’s sluggish economy, the potential for more ECB stimulus and rising U.S. Treasury yields relative to those in the euro region, he said.
“I don’t think for us it’s a high conviction but the probability” of ECB bond purchases “is increasing,” Osborne said by phone yesterday from Toronto. “Given the data, we think it’s something we can’t rule out.”
Overall, Prestige was ranked fifth across the 13 major currency pairs tracked by Bloomberg Rankings, with a score of 59.22. Canadian credit union Desjardins Group of Montreal was No. 1 overall at 63.88.
Austin was a desirable location to set up shop in August 2009 because of its low costs and proximity to his professional network, said Schenker, who previously lived in Houston.
The size of his staff fluctuates depending on projects. While he employs less than 10 now, it has risen to about 20 people. The company has more than 48 clients and also does consulting projects, according to Schenker, who personally makes all his company’s predictions.
“This is very different than a lot of other market research firms where they farm out or delegate critical analysis or forecasts,” Schenker said in a phone interview from Las Vegas before giving a presentation on nickel at an Institute of Scrap Recycling Industries Inc. conference. “I personally meet with the ECB, the Bank of England and OPEC, and these kinds of interactions provide critical qualitative color. It’s not second-hand.”
Schenker has a bachelor’s degree in German and history from the University of Virginia, a master’s degree in German from the University of North Carolina in Chapel Hill and a master’s in applied economics from the University of North Carolina in Greensboro, according to his firm’s website.
Prestige forecasts economic indicators, currencies, industrial metals prices, precious metals prices and oil and gas prices. The firm’s U.S. durable goods outlook was ranked No. 3, as was its aluminum call.
The euro touched $1.3967 on March 13, its strongest level since October 2011, as the ECB signaled confidence that the region’s economy is improving and damped speculation they would cut interest rates or buy securities to boost asset prices.
Prestige sees the euro climbing to $1.41 by the end of 2014, while the median estimate in a Bloomberg survey predicts it will fall to $1.30.
The consensus view on further easing of monetary policy has been whipsawed by ECB officials grappling with low inflation. German inflation, calculated using a harmonized European Union method, slowed in March to 0.9 percent, from 1 percent in February, the Federal Statistics Office said March 28.
ECB President Mario Draghi said April 3 that the bank’s governing council is “unanimous” in exploring tools including asset purchases, which are intended to stimulate growth and inflation. Executive board member Yves Mersch later said deflation risks aren’t imminent, while governing council member Ewald Nowotny signaled no immediate need for action.
Europeans invest about 65 percent of their assets in debt securities and 35 percent in stocks, according to June 2013 International Monetary Fund data on Germany, France, the Netherlands, Italy and Luxembourg, five of the biggest euro-area countries by holdings. Germany and France’s fixed-income holdings are the largest, at 72 percent and 75 percent.
That compares with the 32 percent debt-68 percent equity breakdown for the U.S. In Japan, whose central bank tolerated about 15 years of deflation, the makeup is 79 percent debt and 21 percent stocks.
“If folks are retiring at age 55 and living on defined benefits, pensions that are fixed-income stacked, then, disinflation is OK in that case,” said Schenker, who was in Berlin on winter break from the University of Virginia when the euro was introduced electronically and the German deutsche mark was frozen relative to the euro.
Germany’s experience with hyperinflation in the 1920s is a reason for Schenker’s ECB views. Germany’s Reichsbank was printing marks nonstop in the 1920s to pay reparations from World War I, wiping out a generation’s savings. By 1923 hyperinflation had taken over, and that autumn one dollar was worth 4.2 trillion marks, versus 42 marks in January 1920.
“It was the hyper-inflation which really, completely financially destroyed the pensioners and fragmented the European economy,” he said. “There are a few fundamental reasons why the ECB will remain inflationary hawkish and is not really willing to open the same Pandora’s box that the Fed did.”
Europe’s economy is showing signs of improving. Gross domestic product of the 18 euro-member countries is forecast to increase 1.1 percent in 2014 after contracting the past two years, Bloomberg surveys show. For Schenker, that makes it less likely the ECB will start buying assets in a way that increases the money supply.
“Why would they do something, which in the euro zone would be viewed as quite extreme, to expand their balance sheet in an unsterilized fashion when things are turning around and the risk of inflation is rising?” he said. “Their inflationary thresholds are much lower than ours.”