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Timely perspectives from financial industry experts.

Future Direction of the Euro

4/6/2019

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First a little background: in the wake of the financial crisis in 2008-2009, the ECB had been compelled to cut interest rates to negative; they currently sit at -0.4 %. The intent of negative rates is to encourage institutions to lend money rather than park it at the ECB. If euro banks aren’t lending, then they are forced to pay the ECB to sit on their cash, or take greater risks in their lending practices. This has been hurting EU bank profits for quite some time, as the chart below indicates. 
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Well, some relief may be on the way for EU banks, but this doesn’t necessarily bode well for anyone who is long the EURO. ​
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(NAV of Ishares MSCI Europe Financials ETF).
According to Zerohedge, “the ECB is current analysing whether or not to implement a “tiered deposit rate” through which certain banks wouldn’t have to pay as much interest for sitting in cash.” In other words, the ECB is making this action because it doesn’t see rates ever coming back to positive in the foreseeable future. That should be ringing some bells. ​
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Technically,the Euro has grown tired of the 1.15 handle. We will see it eventually get to previous support at 1.05. Our quantitative trading systems also recently went short again on the Euro. 
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At the same time, we have lowered growth expectations out of the US and the Euro zone.This will force Central Banks to remain neutral to dovish in the foreseeable future. For those expecting some sort of crash to come to the equities market, we really don’t see that happening; and there are a number of reasons for this. 

The most fundamental of these is Central Banks’ willingness to take preventative measures to assuage investors. Central Banks didn’t behave the same way in previous decades. Now, with the global economy so intertwined, and with capital so mobile, it seems they must act in consort. As investors, what does all this mean and how do we take advantage of it? 

  1. First of all, we would do well to remain very liquid. If growth is slowing globally and the rate of interest earned on fixed income is minimal, the opportunity cost of holding a large cash position is also minimal. Moreover, we will be better able to capitalize on high probability opportunities which seem to emerge every few months. 
  2. Secondly, start taking profits on stocks. US market valuations aren’t justified by current or future revenue growth. Markets have risen principally because of this differential between fixed income returns in the Euro-zone and Japan, as well as share buybacks. If companies aren’t investing in their own businesses, that should tell you something. Note, this does not mean going short. 
  3. Look to add on weakness in platinum, gold and solid, high dividend stocks, such as pipeline partnerships. Considering future global growth scenarios are dismal, the quest for yield will only accelerate. If you can find secure, steady income, take it. Gold, as the world’s only currency which can not be inflated, will only rise in demand as Central Banks feed their economies a quick fix. Unless gold becomes illegal to own (as had been the case during the time of FDR) we might change our mind, but for now, this is the best place to park your money long term. Why platinum?Platinum’s principal industrial use had been (and remains to a lesser degree) for use in catalytic converters. Its replacement, palladium, had supplanted platinum. But now the tables have turned. Palladium is trading at about 4 times its long-term price level while platinum is trading far below the price of gold. Historically, this is a bit of an anomaly.​

Related Links:

https://www.reuters.com/article/us-germany-economy-bundesbank/ecb-need-not-change-rate-guidance-just-yet-weidmann-says-idUSKCN1QG199

https://www.bloomberg.com/news/articles/2019-04-04/ecb-members-voiced-concern-about-side-effects-of-low-rates

https://www.ishares.com/us/products/239645/ishares-msci-europe-financials-etf#chartDialog
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https://www.france24.com/en/20190404-ecb-concerned-impact-negative-rates-banks
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