"No one has made money in FX trading the current accounts since the 1970s. Capital flows matter more than trade flows for FX analysis"
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Strategists at CIBC Capital Markets are targeting a continuation in the decline of the Euro-to-Dollar exchange rate (EUR/USD), saying fundamentals continue to favour the Greenback.
Bipan Rai, North America Head, FX Strategy at CIBC has taken aim at a belief the Euro should be higher and the U.S. Dollar lower because of the contrasting fortunes of the U.S. and Eurozone current account.
"One of the most bizarre arguments I’ve heard to fade EUR/USD downside is some variation of the “the current is negative for the US and positive for the Eurozone, so EUR/USD has to appreciate, right?”.
"Our answer – No. Forget what your macroeconomics 101 textbook says and join the real world," says Rai.
The current account is a measure of a country or currency bloc's transactions with the rest of the world, specifically its net trade in goods and services, its net earnings on cross-border investments, and its net transfer payments.
A current account deficit occurs when a country’s trade value of the goods and services it imports exceeds the value of the products it exports.
The textbook says a rising current account deficit leads to an increased supply of a nation’s currency in the foreign exchange markets.
A deficit might therefore lead to the external value of the currency falling.
The opposite would be true for a country that runs a current account surplus.
But, for the Euro-Dollar exchange rate the U.S. current account deficit and Eurozone current account surplus matters little argues Rai.
"The EZ is running a current account surplus because of under-investment in the northern countries (Germany mainly), and weak aggregate demand in the periphery. Not because the EZ has become super-productive," he says.
The Eurozone's current account surplus increased to €285BN (2.5% of euro area GDP) in the four quarters to the first quarter of 2021, according to the European Central Bank.
The U.S. meanwhile saw its current account deficit widen by $20.7BN, or 11.8%, to $195.7BN in the first quarter of 2021, according to statistics from the U.S. Bureau of Economic Analysis.
With regards to the U.S. deficit, Rai says it might not be that large given that it’s actually had a primary surplus income for decades.
"The current account stats don’t capture exports of IP, tech know-how, etc. but it does capture the returns from those factors of production," he says.
Furthermore, the U.S. deficit has no problems with funding.
Typically if a country runs a current account deficit it must attract external investment to ensure the currency stays stable or appreciates.
CIBC says U.S. treasuries and assets still appeal to most foreign investors due to yield/safe haven/reserve appeal.
"Finally, no one has made money in FX trading the current accounts since the 1970s. Capital flows matter more than trade flows for FX analysis," says Rai.
Regarding the Euro, Rai says the European Monetary Union rules (Maastricht, Stability and Growth Pact) along with outmoded fiscal policies (Germany again) are ultimately what prevents the Euro from appreciating and external accounts from rebalancing.
The Eurozone rules mentioned above place an effective straight-jacket on the fiscal policies of its members, ensuring they maintain disciplined budgets.
"Until that’s modified, monetary policy will stay comparatively looser and you can’t count on a structurally stronger Euro," says Rai.
The European Central Bank is expected to next week confirm it will maintain ultra-loose policy settings, that include quantitative easing and the maintenance of record-low interest rates.
This makes a sharp contrast to policy expectations regarding the U.S. Federal Reserve, which looks like it is ready to bring forward the timing of a first rate hike owing to signs the U.S. economy is running hot.
For a foreign exchange market focused on central bank policy divergence this could prompt further downside in Euro-Dollar.
CIBC Capital are short the EUR/USD exchange rate and targeting the 1.15 area.
"If, and once, it gets there we’ll reassess," says Rai.