Conversation: Drivers Behind the Weak Euro and Its Repercussions
Ben Sheen: Hello and thank you for joining us. My name is Ben Sheen, I'm a managing editor here at Stratfor, and I'm joined here today by Mark Fleming-Williams, our economic analyst. On Friday we saw the euro drop to its lowest level against the dollar since 2010, and this morning it continued to drop. Today, we're going to be talking about some of the drivers and implications of that fall. So Mark, what really drove this? What pushed this forward?
Mark Fleming-Williams: Well, it was, the event was on Friday when an interview was released with Mario Draghi, he'd undertaken in Handelsblatt, which is a German newspaper. The reason why it had an effect on the exchange rate is because the markets are in such a heightened state of excitement around quantitative easing (QE) that they see any news — and this was Mario Draghi talking about the subject — they see any news as a belief that QE is likely to happen with the European Central Bank (ECB) next meet on Jan. 22.
Ben: But we don't have the same faith as the markets, though, do we?
Mark: We don't. We think the market is looking at this from a purely economic perspective when, in reality, this is more of a political issue. In order to undertake quantitative easing, then the ECB — full quantitative easing — the ECB would have to buy the sovereign bonds of a lot of peripheral countries, and to do so would alleviate some of the pressure on some of these countries and would undermine some of the political work which Germany has been bringing in in the last couple of years, since the 2012 crisis. So you have the case that Germany has been making, the argument against quantitative easing, and you also don't have, from a political side, you don't have another country making a strong case for. So countries like France and Italy have actually been talking much more about creating more fiscal stimulus rather than the monetary stimulus of quantitative easing because that would, they believe, help stimulate their growth, which is their primary concern right now. So, at the moment, you've got an argument which only has one side, and that side, from a political perspective, is arguing against.
Ben: So, with the markets currently pricing in on an event that we don't think is likely, do you foresee a day of reckoning when quantitative easing doesn't actually come to pass, then?
Mark: Yes, at some stage. So Mario Draghi, who is the ECB president, is the king of being able to move the markets just with his words, without actually having to do anything with it. So, 2012, the crisis, the sovereign debt crisis of 2012, was solved by Mario Draghi stepping up and saying, We will do whatever it takes to save the euro. And the market relaxed, essentially, without him having to do anything. We believe that this is more of the same, essentially, and I wouldn't put it past him to be able to make the markets believe that QE is imminent for a much longer time than, perhaps, anyone else would be able to. Generally, though, yes, there is a readjustment of some sort, most likely the place to look will be in the bond yields. They, at the moment, Germany's bond yields are around 0.5 percent for the 10-year bonds; Italy, Spain, France, they're all at unnaturally low levels because the market believes that quantitative easing is imminent. So this is where we'll be looking for, when the markets finally do lose patience, then this is where we'll be looking for that change.
Ben: Absolutely. But, am I right in thinking that quantitative easing isn't the only driver for change in exchange rates itself?
Mark: Yes, absolutely. I mean it's, the weakness of the euro and the strength of the dollar is not just about the quantitative easing debate. The two economies have been diverging for a while. The Americans are forecast to be growing at 3.1 percent in 2015; the talk around the American economy is about raising the interest rates, perhaps, in 2015 in order to keep inflation under control. In Europe, the forecast is 1.3 percent, and obviously we're having this quantitative easing debate as a potential solution to the risk of deflation. So you've got these two completely different economies, which have now broken off from each other and are heading in different directions. So, as a result, the exchange rate is doing what it should be doing.
Ben: Very much so. And this seems like a trend that's set to continue. I mean, do you foresee any difficulties for either side as this moves forward?
Mark: Well, normally in this situation you would look at the trade balance. That's where the currency strength and weakness could create problems. So in a country in America's situation, with a strengthening dollar, you would be looking to see if their exports would become uncompetitive in the global market. As it is, America's exposure, export exposure is actually quite minimal. It's about 13 percent of gross domestic product, which, if you compare it to Germany's, which is more like 50 percent, it just shows that America is not as dependent on exports as it could be. And then on the other side, on the European side, then you'd be looking at, to see if a weakening euro impacts the European ability to spend on imports. But then again, the European situation is favorable. They run a current account surplus of around 2.5 percent, which means that they export much more than they import. And the one major sector in which they do import is energy, and, again, the timing is slightly on their side because you have a huge fall in the oil price in the last year. So the oil prices dropped 46 percent in 2014, the euro's dropped 9 percent. So, still, even after the drop in the euro, they're still on a net gain in terms of their energy imports. So, as things stand, we see this trend of the weakening euro and the strengthening dollar not to create difficulties and actually to create more benefits for both sides.
Ben: So it could make for an interesting opening to 2015. Mark, thank you so much for explaining what's currently going on in the European markets. For more information on this topic and many more, please read Stratfor.com. Thank you.