Heard on the Street
No Room for Complacency on Euro’s Path
The euro can still fall against the dollar but it’s a riskier bet
By Richard Barley
March 23, 2015 12:20 p.m. ET
The U.S. Federal Reserve has delivered an unpleasant jolt to one of 2015’s most popular trade ideas: the seemingly inexorable decline in the euro.
Huge swings in the euro against the dollar—including a round trip from $1.06 to $1.10 and back in less than 24 hours—have shaken the market. On Monday the single currency continued to climb, rising back above $1.09. The euro can still resume falling, but the risks to this trade are a good deal higher than previously.
The Fed dealt two blows last week to those betting on a weaker euro. First, it sided with the bond market in lowering its projections for the path of interest rates, with fewer, slower increases signaled: the median forecast for end-2015 is now for a rate of 0.625%, versus 1.125% in December. The foreign-exchange market had run too far with its belief that monetary policy would diverge sharply between the U.S. and Europe. Second, the Fed dropped hints of concern about the pace of appreciation in the dollar.
The result was foreign-exchange fireworks. Such sharp movements are worthy of attention as they can signal turning points. Moreover, some of the factors that have driven the euro lower are beginning to look tired. The expected growth gap between the eurozone and U.S. economies for 2015 has narrowed; the concept of monetary divergence has been so extensively discussed that it is surely priced in; and the pace of the euro’s decline before last week had been breakneck.
But there is still reason to believe the euro could move lower. A key uncertainty now surrounds U.S. inflation—and in particular wage inflation. The failure of U.S. wages to respond to tighter labor market conditions remains puzzling. Signs that pay is rising would be welcome to dollar bulls.
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