Euro Climbs Relentlessly, While Greenback Is Mixed

The euro’s strength is surely partly a reflection of US dollar weakness, but it is also a reflection of the improved sentiment among investors. The initial dollar losses at the start of the year was largely a correction that is common after a Fed hike. This is more or less what happened at the start of 2016 as well, following the Fed hike in December 2015. However, the correction morphed into something more profound beginning in late April as it became clear that the National Front was going to be defeated in France.   

We had suggested that there was not populist-nationalist wave sweeping across the world, though that was the consensus narrative. Instead, we argued that the center-right party in the two-party systems in the UK and US adopted some of the rhetoric and policies of the populist-nationalists, but that the multi-party systems in Europe served to dilute the same forces. The center-right in Europe ran away from the populist-nationalists, even if appropriating some of the anti-immigration rhetoric.  

Meanwhile, the economic outlook of the US was questioned. The prospect for supply-side deregulation, tax reform,and infrastructure spending, promised by the new US President, whose party enjoyed a majority in Congress has dimmed, as the legislative process has become stymied not so much by the opposition Democrats, but by the inability of the Republican Party to harness its majority. The strategy of using its majority to ride roughshod over the minority is at the core of both the health care efforts and tax reform.  

At the same time, investors seem to put much stock in the forward guidance of some central banks, including the ECB, which have signaled a less accommodative stance is going forward. Yet, they give little weight to the Federal Reserve, which has indicated it will most likely begin shrinking its balance sheet and continuing the gradual normalization of monetary policy. The ECB’s balance sheet will likely be expanding for nearly another year (mid-2018), and its deposit rate is likely to still be negative in late 2018.