Euro Break Out!
Europe is Moving in Different Directions
The euro made new high this week, the highest since late November. Ten year yields have fallen 10-25 basis points in Greece, Portugal and Spain. The rally in the periphery is generating some positive momentum for the Euro. It seems that Germany is balking at boosting the size of the EFSF, that perhaps the countries with less than triple-A credit should boost their contributions. It seems hardly practical that Italy and Spain for example can really afford to increase their external commitments.
The German IFO hit a record high in December. The German economy is booming and leading the growth for the EMU. The stock market hit 2 1/2 year highs earlier this week. German strong growth stands in sharp contrast to contraction or stagnation in the periphery and weak growth outside of a Germany and a couple of other countries. Monetary policy is arguably too loose for Germany and too tight for most on the periphery, resulting in low real interest rates in Germany as inflation outstrips desired levels. Most of the official focus has the debt dynamics, but less attention appears to be directed at the underlying problem – namely, the deterioration of the competitiveness of countries on the periphery expressed through the real effective exchange rate and unit labor costs.
US-German 2-year interest rate differential as an important factor in the euro-dollar exchange rate. It has moved another 10 basis points in Germanys favor this week and now stands near 68 basis points, its widest since January 2009. It had widened by 31 basis points last week and was flat in the first week of the year. The widening has helped fuel the near 4.5% rally in the euro over the past two weeks. The Euro broke out today, moving above the 1.35 level and close next to 1.36.
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