Euro is fair value in 2014? The EUR/USD trade has been stuck in this mid 1.35 to 1.38 range for quite sometime now. A lot of people are scratching their head on whether the Euro is overvalued. The European Commission vice president Antonio Tajani said recently, that the Euro was overvalued and urged the zone’s central bank to help exporters by weakening the Euro single currency. There has been a lot of ECB talk on a 1 trillion Euro QE plan, negative interest rates and a whole host of measures to do just this. Each time this talk occurs, the Euro takes a spike down. But the markets are not stupid, talk is cheap, the markets want the ECB to “show me the money,” they then tend to bounce right back up. So what’s the story here?
I have always believed that virtual currency valuations are driven primarily by two major factors – money supply and GDP, within the currency’s domain. Some have cited that inflation is a cause as well, but I would take this as symptom, not a cause, though if a central bank uses this as a metric, it can have short term effects in price movements. Interest rates too I believe are a symptoms not causes, it is just a tool for the central banks to move on their policy goals.
So first let’s look at money supply. For the Dollar, M2 has been hovering around 6% per annum – click here. For the Euro zone, it is tracking around 2% per annum – click here. Looking at just this data point, it would appear that the Euro is being debased less and hence gives a bid to the Euro.
But we also have to look at the economic activity of the two currency regimes, to really see if the monetary base is justified to be grown or, is just a debasement of the currency. Looking at the Dollar area, the US, the GDP growth rate is around 2.5 to 3%. The Euro zone area GDP growth is around 0 to 0.5% – click here for the data of the two. So the higher money supply increases for the Dollar are somewhat justified.
When averaging the two data points of the two currency regimes, it gives a very slight advantage to the Euro. Perhaps this is why the Euro remains stubbornly high. Since there has not been great movement in these data points recently, it also explains why the EUR/USD trade has been a bit boring.
Markets are an expectations game so what people think will happen, will move this market. If the ECB really does act, Euro will drop. If they don’t act, very likely the economy in the Euro zone will continue to stagnate. The US economy has been thought to be beginning to take off, if it does, it will give a boost for the Dollar. But US economic data has been coming in flat. Until the expectations become more clear, I expect the EUR/USD trade to continue to be flat.
Blue Point Trading, William Thompson