We got a big move in the euro yesterday and this is feeding into all asset markets in the near term.
Here Commerz on the news flow:
The question all asset and wealth allocators must be asking themselves this morning is whether this is the start of a meaningful medium term trend of euro strength? The issue boils down to whether the euro is to become the new Japanese Yen as her central bank sees no problem from deflation and sustained (albeit) slow growth.
In many ways she mirrors Japan, especially Germany which is now a third of the Euro zone’s GDP.
And lets be clear, Germany looks like Japan used to.
But Germany is a part of the Euro zone and euro currency so lets go through the comparisons.
Low growth and near zero inflation, trade surpluses, near zero credit growth, under capitalized banking sector, high government debt to gdp, aging demographics, relatively high consumer savings vs US, UK and a conventional central bank that is shunning non conventional monetary tools. On the divergences between herself and Japan is high government ratios as a share of the economy (Japan’s is still low), and importantly high consumer debt levels in the euro zone.
On a relative basis now that the world appears to have lost Japan as the safe heaven currency the euro could well be the best alternative, for now. On a macro strategy level it is clear that ‘the best’ fiat currency is becoming ever worse! On a relative basis gold as the last safe heaven currency is looking better and better especially at these low valuations and very stretched asset market valuations.
For now the euro appears the best fit to the safe heaven fiat currency. We must recall that the Yen continued to strengthen even as deflation increased. What supported the yen for so long was the positive real interest rate on her currency relative to negative real interest rates seen in the west. Sso what do we see at present? Do we see positive real interest rates, on a relative basis vs the US and UK for the eurozone?
The summary answer is, yes, we do!
At present all real interest rates are negative on the over night rate but euro real rate is the least negative. To explain, the over night rate for the eurozone is +0.25% and the inflation rate is +0.8% so the real interest rate return is a -0.55% p.a. The UK’s negative interest rate at present is +0.5% overnight less +1.9% ie -1.4% p.a. in real terms (or 140 basis points). Its a more aggressively negative interest rate environment. On the ten year the spread difference between uk and german 10 year is 114 basis points at present. (On this basis it could be argued Germany is currently paying a 26 basis point positive premium to the UK at present). Fiscally challenged states like Spain now borrow at very comparable rates as the UK on the ten year. (In real terms the rate is much higher of course). On a European average rate 5 to 10yr paper comparison its clear the zone offers a relatively better return than her US and UK alternatives. These sorts of issues play directly into longer term FX valuation models. This discussion is separate to any of risk, note.
Lets look at the near term as FX is moving and threatening a trend here:
Here Barcap with their latest technical views:
Here below a couple of reports from Nomura earlier today.
And here Nomura on the USDJPY
And here Citi Wealth with their weekly from a few days ago. Like many, wrong footed by the ECB once again.
And here citi london getting it right on the euro.
Much more to come on these FX issues, near term and longer term.
Finally of all the currencies and even across assets, on a relative basis, gold is looking more and more attractive. Whilst rates remain, real term, negative on so many currencies and growth remains so low gold should shine.Whilst returns on risk assets remain so low as prices get compressed to the upside gold should shine. US indexes have not seen a 10% correction now since 2011 whereas gold has seen a substantial correction from her high. On a cross multi asset market basis bullion is extremely relatively attractive here.
Here Commerz with a near term bullion technical run through
Rich