Opinion Leader | Guan Tao
On July 15, the exchange rate of the euro against the dollar closed at 1.0085, down 11.3% since the beginning of the year, approaching the parity level. From July 12 to 14, the euro exchange rate fell below 1 for three consecutive days, a new low since the end of 2002. The dollar index rose steadily, comprehensively crushing the euro, pound and yen. From the beginning of the year to July 15, it rose 12.9%, hitting a 20-year high. During the same period, the appreciation of the US dollar against the euro contributed 56% of the increase of the US index.
The spread measuring the attractiveness of asset prices among countries has an important impact on the trend of exchange rates, but there are two "quirks" in the important interest rates in the United States and Europe. First, the narrowing of the yield spread of 10-year German government bonds did not save the decline of the euro. Since the beginning of this year, the yields of US and European government bonds have risen significantly, the yield of 10-year US bonds has exceeded 3%, and the yield of 10-year German bonds has also got rid of negative yields. After May, the US debt peaked and fell back, and the interest margin between the US and Germany gradually narrowed. On July 15, compared with the peak in April, it fell by 36 basis points, and during the period, it fell by 59 basis points at most. The second is the inversion of the US bond yield curve and the steepening of the German bond yield curve. Since the 10-year and two-year interest rate differentials of US bonds peaked and fell in April, the yield curve of US bonds has been further flattened. On July 6, the upside down began, and on July 15, the upside down began by 20 basis points, which is equivalent to the upside down during the past recession; The yield difference between 10-year and two-year German bonds is close to 100 basis points.
On the surface, the US transaction recession expectation and the European transaction stagflation expectation are more consistent with their respective economic status. The US economy is moving from an overheated state to a slowing stage. In the first quarter, the real GDP grew negatively. In the second quarter, indicators such as PMI, durable goods orders and consumer confidence further weakened. The market speculates that the US economy may even have entered a technical recession. The economic recovery in Europe was not as strong as that in the United States. The euro area was hit hard by the epidemic. Last year, the physical volume of the economy had not yet recovered to the pre epidemic level. It is also the main victim of imported inflation. The Ukrainian crisis has significantly increased its stagflation risk.
However, high inflation is a global phenomenon. If the US economic recession leads to a decline in global energy prices, Europe may quickly switch from stagflation mode to recession mode. In this way, the German bond yield curve is not a simple stagflation transaction. In fact, it may be that international capital is not optimistic about the prospects of Europe and the risk aversion to the United States has triggered two "paradoxes" in the bond market.
Further, the euro still has three "persistent diseases". The first is the loose finance and unbalanced debt distribution within the EU. As the leverage ratio of governments in southern European countries is significantly higher than that in northern Europe, as long as the monetary tightening cycle enters, the hidden danger of European debt crisis will reappear. Once the economic growth decline and the fiscal passive contraction meet, economic problems may cause social problems. This leads to the second "stubborn disease" that European integration lacks the basis for political integration. The EU is more like an alliance of countries than a federal country like the United States. If people in southern European countries can't stand high inflation and declining welfare, resulting in social unrest, the euro will be further hit. Recently, because the "Five Star Movement" party refused to support the Italian government's rescue plan to help people cope with the rising cost of energy and living, the differences within the ruling coalition were exposed, and Prime Minister Draghi once wanted to resign. The third is that the conflict between Russia and Ukraine is not the final decision of Europe, which has been unable to get off. Natural gas accounts for 25% of Germany's total energy consumption, while 55% of Germany's natural gas comes from Russia. Although the EU advocates saving energy together to alleviate Germany's urgent need, it is not easy to adjust the energy structure in the short term. In particular, people in countries without the ability to subsidize cannot bear the fact that natural gas still has to be delivered to Germany at high prices, which further aggravates the second "stubborn disease". Recently, the maintenance of Beixi No. 1 natural gas forced German energy giants to divert gas storage in winter, which led to another decline in gas storage level. There is greater uncertainty about how to spend the winter this year.
The performance of the euro in the year can only be seen from the "face" of the dollar. The sharp fall of the euro failed to prevent Europe from snapping up energy all over the world. By May this year, the EU had run a trade deficit for the 10th consecutive month. In that month, Germany had a quarterly adjusted deficit of 1 billion euros for the first time in 30 years. If the current account deficit of the EU continues to deteriorate, it will further intensify the pressure on euro depreciation. Therefore, the "turnaround" of the euro will probably wait for the dollar to turn.
Curbing inflation is the top priority of the Federal Reserve. In June, the US CPI exceeded expectations again, with a year-on-year growth of 9.1%. However, the strong non farm data and retail data in June provided sufficient cushion for contraction to trigger recession, making the Federal Reserve unable to turn around easily. Federal Reserve officials, including Powell, have repeatedly said that only when inflation trends back to a reasonable range can it be seen. Considering the base effect and leading indicators of house prices and rents, the US CPI may remain stubborn in the third quarter, and the fourth quarter will become particularly important. The unprecedented radical tightening of the Federal Reserve and the tightening of the European Central Bank were judged high and low.
Risk aversion will also support the dollar. At present, the tightening of the Federal Reserve will either destroy the domestic demand of the United States or attract the return of dollars to trigger the overseas debt crisis. The upside down of the US bond yield curve has been defined by the market as the Federal Reserve artificially creating a global economic recession, leading demand contraction to balance the pressure of high inflation. Once the dollar liquidity crisis evolves into financial systemic risk and the economy shrinks rapidly, risk aversion will be concentrated and released, pushing the dollar to peak and fall back. Since the dollar's strength has not yet forced the Federal Reserve to turn, let the bullet fly for a while.
(Author Department BOC Securities Global Chief Economist)
Published on China Newsweek Magazine, Issue 1053, July 25, 2022
Magazine Title: The exchange rate of the euro against the dollar is close to parity, but it is hard to say the bottom
Author: Guan Tao
(About the author of this article: Global Chief Economist of BOC Securities)
