The financial press is filled with articles about the recent EURO weakness. During the last week the EU currency has fallen about 1.5 percent. Many pundits have opined that it is the Ukraine situation and Gaza that have made investors uneasy, thus the move into U.S. dollars. In a July 22 Bloomberg article, “Draghi Cedes Euro Control to Yellen on Fed Bets,” it is suggested that the DOLLAR is rising in anticipation of moves by the FED, especially now that the ECB has gone to negative yields on reserves. The problem for the Fed argument is that yields in the U.S. have actually softened during the last week and Fed communication has been muddled over when interest rates might possibly rise. When the ECB announced a negative interest rate June 5 the EURO/DOLLAR made a low of 1.3503. Today we are trading at 1.3465, a little below the 1.35 low but well below that day’s close of 1.3650.
If it is not Russia, Gaza, or higher U.S rates guiding the euro lower than what other element could be affecting investors? If I would venture a guess it would be in an article in yesterday’s FT: “Bundesbank Shifts Stance to Support Pay Rises.” This is a 180-degree turn for the backbone of European monetarism. A couple of weeks ago, Bundesbank President Jens Weidmann made some statements in support of Mario Draghi’s recent actions to ease rates and enhance liquidity to prevent a further drop in inflation and, of course, the euro. I thought Weidmann’s comments were of a political nature so as to not upset Merkel and the EU establishment in times of negative yields.
But the FT article takes the Bundesbank statement to a new level and must be a sign that even in Germany the economy is starting to slow. The article opens with the line, “Germany’s Bundesbank has backed the push by trade unions for inflation-busting wage settlements ….” It was Bundesbank chief economist Jens Ulbrich who called recent wage trends moderate,given the strength in the German economy. If the Bundesbank has capitulated on the wage issue look for ECB President Draghi to feel renewed strength in his efforts to weaken the EURO and placate the French and European peripheries who have continued to complain about the impact from an overly strong euro.
The only problem for the ECB and Draghi is that Janet Yellen will be attentive to the Bundesbank call for wage increases and use it as a reason to keep U.S. interest rates low for as long as possible to ensure a recovery in U.S. wages. If the Bundesbank can push for some increased wage inflation, then full speed ahead in the efforts to remove the drag of low stagnant wages for American workers.
***Tonight, the Reserve Bank Of New Zealand raised the Overnight Cash Rate (OCR) to 3.5 percent from 3.25. The KIWI currency though declined in value as the market shrugged off higher rates, an unusual response in the face of global zero interest rates. Governor Graeme Wheeler noted in the release that “with the exchange rate yet to adjust to weakening commodity prices, the level of N.Z. dollar is unjustified and unsustainable and there is potential for a significant fall.” We have heard this before from the RBNZ governor but this time the KIWI actually reacted by selling off rather than rising in the face of higher interest rates, something to be watching. The KIWI is a favorite of the carry trade investors from Japan and if the N.Z. dollar fails to react positively to higher rates, carry trade investors may begin to unwind long-held positions.