The euro plunged to a 12-year low against the dollar today. Why is the common European currency declining and what does its slide mean for the financial markets and gold prices?
Before the rebound, the euro dropped below $1.05. It is a bit of shameful performance for the second most important international currency (see the chart below). The euro is actually the biggest loser among the currencies of developed countries. It has weakened almost 8 percent this year measured by the Bloomberg’s weighted index and over 12 percent against the greenback (which is more than during the infamous third quarter of 2008).
Figure 1: The USD/EUR exchange rate between 1999 and March 6, 2015.
What are the reasons of such a big depreciation? First, the ECB has started buying government bonds. It increased the money base and further decreased the yields. The yields on many European bonds are extremely low and often negative, which induces investors to shift their capital abroad.
Second, we are witnessing an uncommon divergence between the main central banks. It is a really big thing. The Fed is believed to hike rates over the next few months, while the second-biggest economic area is experiencing QE and a bulk of bonds trades at negative interest rates. Just look at the yields in the U.S. and Europe. 10-year U.S. Treasuries are trading above 2 percent, while the yield on 10-year German government bonds stands at less than 0.2 percent, more than 10 times lower. Not surprisingly, U.S. assets are much more appealing right now, which attracts international capital. Needless to say, selling European bonds and buying U.S. assets weakens the euro and strengthens the greenback.
Third, there are also other, let’s call them structural or internal, factors in the Eurozone, which discourage investing in euro-denominated assets. The recovery in the Eurozone is rather sluggish and some peripheral countries are still struggling with many economic problems. And do not forget about the Greek never ending story - concerns over a Grexit are an additional burden on the euro.
How can the weakening of the common currency affect the gold market? The weak euro may be positive for gold prices in terms of the common currency, especially if the concerns about the Greek exit from the Eurozone appear again and spur demand for the yellow metal as a safe haven. The gold price in the euro is rising since the second half of February.
Second, the euro’s decline to a large extent simply reflects a rising U.S. dollar. This fact is negative for the gold prices expressed in the greenback, at least the U.S. dollar seems like the best safe haven right now. However, any increase in global uncertainty, due to the crisis in Greece or China’s slowdown, may drive safe-haven flows into both the dollar and gold.
Moreover, the surge in the greenback may even further reduce U.S. inflation as import prices will fall. The gaining U.S. dollar may also squeeze the American exporters and companies with international operations, limiting economic growth (measured by the GDP), which could force the Fed to postpone the rate hike.
The bottom line is that the divergences in global monetary policies are the main reasons for the euro’s slide and the U.S. dollar’s strengthening. A gaining greenback is bad news for gold prices (in terms of the U.S. dollar), however we doubt whether the Fed could withstand the possible rise in the greenback above parity with the euro and raise interest rates regardless of the international situation.
Thank you.
Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor
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