Friday, May 21, 2010

Euro decline rational or irrational?


Jean-Claude Juncker, Luxembourg prime minister and EU head, suggests that the euro's decline is "largely due to irrational approaches of the financial markets."

The euro declines and policy officials believe it is an irrational response. There could be an alternative explanation. The market has seen the "EU TARP" or stabilization program and note a lack of government coordination and decided that they do not want to hold the currency. The graph shows the program and it is hard to see how this is going to solve the problem.

Growth rates in the EU will decline. Risk is on the rise. Discussions of a break-up have been ongoing. The ECB has bought bonds outright in the market and seems to be shifting policy to be sensitive to fiscal growth issues.


Why should we be surprised about euro decline? The issue on the minds of investors is how much further will the decline go. This is an issue of feedback effects. If the stock and credit markets continue to sell-off, then there will be a feedback away from the currency. If growth slows in the economic data next month, the euro will continue its decline. If exports improve and growth follows the fourth quarter 2009 path, then we will see a euro rally.

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