The European Union (EU) constitution was dealt a double blow,
first by a French "no" vote on 29-May and then by a follow on
"no" from the Netherlands on 01-Jun. To add insult to injury, one
low level Italian diplomat quickly called for a referendum in
Italy to decide if a return to the lira was warranted.
Additionally, Prime Minister Tony Blair, who took over leadership
of the EU on 01-Jul, indefinitely postponed the British
referendum on the EU constitution.
This news along with plenty of speculation about the
repercussions dominated the international headlines for much of
the month of June. Not surprisingly, all the hubbub about the EU
had a direct impact on the FX market. The euro fell to a new
seven month low following the French referendum, reaching a low
of 1.2371 and the "single currency" has been under pressure ever
since. Probes below the 1.2000 level were seen ahead of 30-Jun,
suggesting additional near term downside potential toward 1.1756
and beyond.
Since the inception of the euro in 1999 central banks,
especially those in Asia and the Middle East were seen
diversifying out of dollars into the euro. They were not only
looking to scale back their substantial dollar holdings in the
face of a declining market, but they also sought the higher
returns available in the eurozone. However, returns on eurozone
deposits slipped below those in the United States in December and
the FED's string of rate hikes bodes well for those differentials
to further widen. Combine the better returns in the US and a
generally more favorable dollar outlook with the specter of
continued political turmoil within the EU and it seems there is
little incentive to hold euros at this point.
Truth be told, the EU was facing some rather significant
hurdles long before the double "noes" derailed confidence. Many
of these hurdles are associated with expansion. Discontent on the
part of established club members with the admission of central
European countries in May-04 and general hostilities about the
proposed admittance of Turkey played significant roles in the
recent referendums. In addition, diverging economic performance,
productivity growth, inflation and fiscal performance among
member nations are all fodder for further turmoil.
Worthy of particular note is the broad based economic malaise
in Italy. Italian consumer product manufacturers are losing their
battle with Asia and consequently the trade balance is moving
into the red. Unemployment is up, as is the budget deficit. Being
part of the euro, and therefore having a relatively high exchange
rate, essentially thwarts any effort to compete with Asia on
price. Without its own currency, Italy is unable to devalue out
of its non-competitive position. Hence, the aforementioned
comments by Italian Minister Maroni. Countries such as Portugal
and Greece are also in rather dismal economic health. The budget
deficit of the former has already reached 7% of GDP.
Many have noted that the EU constitution may be dead, but it's
not buried yet. I'm not so sure that I would agree as approval of
all 25 member counties is needed for ratification. The initial
thought was that any dissent was likely to come from newer or
smaller EU countries and that a little economic arm twisting by
the likes of France and the Netherlands might encourage them to
reconsider. Unquestionably the long standing skepticism of the
Brits was going to be an issue. However, rejection of the
constitution by two of the founding members of the EU certainly
throws a wrench in the works.
I don't believe that we need to worry about the European
Monetary Union (EMU) breaking up any time soon. In other words,
the euro will continue to be actively traded on the global spot
market. A Reuters poll early in June suggested there is only a 5%
chance of an EMU collapse within the next 15 years. However,
around the same time the German weekly magazine Stern reported
that the failure of the EMU was discussed at a meeting attended
by German Finance Minister Hans Eichel and Bundesbank President
Axel Weber. Having said that, I don't think there is any question
that there is a greater risk premium attached to the euro than
there was a month ago.
In the months ahead, look for continued political wrangling
within the EU. Further bad news is likely to be forthcoming,
which should help keep the euro under pressure, creating trading
opportunities not only against the dollar, but in the cross rates
as well.
Peter Grant is VP of Operations for CFS Capital Management
(http://www.cfscap.com), an
alternative investment firm in Lakewood, Colorado. This article
is an excerpt from our monthly newsletter 'The Alternative' which
can be read online at http://www.cfscap.com/news.htm.
Emails may be sent to pgrant@cfscap.com
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Bank of England and ECB Hold Steady, Indonesia Cuts CNBC.com [CNBC] ----------------------- MULTI CURRENCIES VS THE DOLLAR Tune In: CNBC's "Money in Motion Currency Trading" airs on Fridays at 5:30pm and repeats on Saturdays at 7pm. Learn more: The essential vocabulary for currency trading is on Key Currency ...
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