When European Central Bank (ECB) President Mario Draghi recently announced that the ECB would continue its bond-buying program at a rate of 60 billion euros per month, it threw many investors for a loop. Many of these investors were looking for a bigger move. Draghi did state that this extension will last through March 2017, which leaves the door open for future “stimulus.” But this announcement simply didn’t get the job done, at least for speculators.
Some of those speculators that were expecting a big announcement of increased stimulus set up positions to short the euro. In most cases, an accommodative monetary policy announcement will weaken the related currency and boost equities. In this case, it was akin to an individual company reporting great results but missing expectations, which ends up as a “buy on the rumor, sell on the news” event. The irony here is that the traders who got it wrong were correct. (For more, see: The Fundamentals of Draghinomics.)
Currency Relativity
The euro spiked after Draghi’s announcement because it wasn’t as big of a stimulus package as expected. However, as is often the case, the initial investor reaction was incorrect. It’s very possible that the euro and U.S. dollar moves as high as 1.12 in the near future, possibly even a little higher, but that will not be sustainable over the course of the next year. Eventually, investors will realize that even though Draghi’s announcement didn’t exceed expectations, the ECB is still printing money while the Federal Reserve has completed its accommodative policies and is likely to raise rates. When a central bank raises rates, the value of its currency increases. The negative is that it will hurt equities, but that’s a story for another time.
Another factor is that while Europe and the United States are suffering from aging populations, which hurts consumer spending, the United States has the Millennial generation to pick up the slack down the road, whereas Europe has no second wind. The ECB is doing everything it can to prevent deflation by attempting to fuel inflation. (For more, see: Money Habits of the Millennials.)
The ECB also wants its policies to lead to job gains and economic growth. Unfortunately, that’s not going to happen. As the majority of the 19 economies within the Eurozone weaken, the euro currency will remain under pressure. There is also some added fuel with France voting to the far right for the National Front in its December 6 elections, which is likely related to the recent attacks in Paris. If the National Front wins the election in 2017, the euro will be under even more pressure.
In the United States, total-debt-to-GDP is higher than it was in 1933. This is a big negative, but not from a currency standpoint because we will be forced to deleverage in order to save the economy for the long haul. As all this debt is paid off, the U.S. dollar will appreciate.
Investment Opportunity
If you want to short the euro without foreign exchange, you might want to look into ProShares UltraShort Euro (EUO), which tracks 2x the inverse performance of the euro. Despite a recent slide, this exchange-traded fund (ETF) has appreciated 20.31% over the past year. It comes with a lofty 0.96% expense ratio and trades at less than 808,127 shares per day. Therefore, it’s not for the average retail investor unless a specific game plan is devised prior to initiating a position. Emotion cannot be a factor. If you look at EUO since its inception, it has had many peaks and valleys, which presents excellent trading opportunities if you plan correctly. (For more, see: Bet Against the Euro With EUO ETF.)
The Bottom Line
The euro might appreciate in the near future, but the real trend is down. Based on current global economic conditions, central bank policies and the massive deleveraging that must eventually take place domestically, you should fully expect the U.S. dollar to gain against the euro over the next year, with parity being a possibility.
