EUR/USD is grossly over-valued, according to our valuation model and common sense. There are many reasons that have been offered to help explain this rising trend in EUR/USD in the past six years. But none of these factors convincingly explains why the EUR is so over-valued, i.e., why its level is so extraordinarily high. In this note, we propose a new hypothesis.
In recent years, US real money investors have aggressively diversified out of USD assets. Most of the rest of the world have also been reducing their financial ‘home bias’ by diversifying out of their own domestic asset markets. However, European investment funds (IFs) have diversified more within the Eurozone than outside the Eurozone, i.e., they diversified out of their own
countries but into other EMU member countries, and not out of the Eurozone. The EUR, therefore, should be strong if everyone else in the world is diversifying while the Europeans are not.
Stephen Roach, Head Economist, Morgan Stanley
Weekly Bank Research Center 04-07-08
Why Is the EUR So Strong: A New Hypothesis
Stephen Roach, Head Economist, Morgan Stanley
EUR/USD is grossly over-valued, according to our valuation model and common sense. There are many reasons that have been offered to help explain this rising trend in EUR/USD in the past six years. But none of these factors convincingly explains why the EUR is so over-valued, i.e., why its level is so extraordinarily high. In this note, we propose a new hypothesis. In recent years, US real money investors have aggressively diversified out of USD assets. Most of the rest of the world have also been reducing their financial ‘home bias’ by diversifying out of their own domestic asset markets. However, European investment funds (IFs) have diversified more within the Eurozone than outside the Eurozone, i.e., they diversified out of their own countries but into other EMU member countries, and not out of the Eurozone. The EUR, therefore, should be strong if everyone else in the world is diversifying while the Europeans are not.
Is Bernanke About to Pause?
Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank
In the past week Fed chairman Ben Bernanke presented his semi-annual testimony to Congress. Generally, the testimony did not uncork any surprises. Still there was a bit of new information, which may provide some indications about the minutes from the FOMC meeting in March due to be released in the coming week. First of all, Bernanke acknowledged that growth prospects had deteriorated further since the January meeting when the FOMC members expected growth of 1.3-2.0% Q4/Q4 in 2008 and 2.1-2.7% Q4/Q4 in 2009. Moreover, Ben Bernanke for the first time mentioned the possibility that the US economy is recession-bound in H1 08. Overall, he painted a bleaker picture of the economy on the back of the financial problems, the continued downturn in the housing market, the high food and energy prices and the tight credit conditions. Thus, there are prospects of a downward revision of the growth estimates for 2008 and possibly also for 2009 when the new estimates from the FOMC members are in connection with minutes from the April FOMC meeting.
Fundamentals: Another Fed Ease
E. Silvia, Ph.D. Chief Economist, Wachovia
Expectations of economic growth and inflation suggest another Fed ease later this month as well as continued low long-term interest rates this year. This week we received indications that the overall real economic growth should remain below trend over the next two quarters with slower consumer spending and continuation of the housing market correction. Job losses in recent months are consistent with our expectation of slower income growth and consumer spending in the first half of the year. Second, inflation remains slightly above the Fed’s target range with the trend in food and commodity prices being an issue. Based upon our expectations for growth and inflation, we expect the Fed will retain a bias to ease another 25 bp at the April 29/30 meeting.
Global Risks From U.S. Consumer Mounting
Steve Chan, Economist, TD Bank Financial Group
In our latest TD Economics’ Quarterly Forecast, we discuss the importance of the U.S. consumer to the health of the global economy. In recent years, the GDP share of U.S. consumer spending has surged from 67% to 72%, fuelling rapid growth in imports from across the globe. It is very unlikely that ongoing rapid expansion of domestic spending in countries such as China and India will be able to fully offset the headwinds from a weakening U.S. consumer appetite, leading to a substantial slowing in world GDP expansion. This message was echoed in the latest IMF world forecast, which won’t be formally released until next week but was leaked to investors on Wednesday. The IMF marked down its U.S. growth forecast by a full percentage point in 2008, to only 0.5%, and scaled back its view for next year to only 0.6%. The global pace of expansion was also pared back substantially – to under 4% – with the organization citing a 25% risk of a world recession. Meanwhile, another high-profile economic assessment was delivered by Fed Chairman Bernanke in his usual testimony before Congress. He was quiet on any guidance on interest rates, but noted that real GDP is not expected to grow much, “if at all, over the first half of 2008 and could even contract slightly”.
Tighter Credit Conditions Will Weaken UK Economy and Raise Default Rates
Trevor Williams, Chief Economist at Lloyds TSB Financial Markets
The latest UK credit conditions survey from the Bank of England made grim reading. It suggested that credit conditions will tighten even further for UK households and companies in the next three months, after a pronounced tightening in the three months to March 2008, which itself was more than was expected at the end of 2007. At the same time, the survey reported that lenders also intended to widen spreads, effectively raising the cost of borrowing to households and companies. Thus it was no surprise that the report also showed that a greater number of lenders expected default rates on loans in the UK to rise, after been higher than expected in the previous three month period.
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