Euro Takes Strain As Rebalancing Call Tested

The euro zone may not like it but the euro is likely to stay bid as the resolve to rebalance the global economy, trumpeted at the Group of 20 Pittsburgh summit, starts to look threadbare. With the euro breaking above $1.50 on Wednesday, the market will have the all-time high of $1.6018 in its sights. Rebalancing means a weaker dollar and the liquidity of euro/dollar offers the easiest route for the market.

It wasn't meant to be this way. The G20 communique urged a transition to a more balanced pattern of global growth. Western policymakers have interpreted this as calling for emerging Asian states to rebalance their export-led economies by increasing domestic demand.

U.S. Federal Reserve Chairman Ben Bernanke said on Oct. 19 that "trade surpluses achieved through policies that artificially enhance incentives for domestic savings and the production of export goods distort the mix of domestic industries and the allocation of resources".

The problem is that the economic price of a swift rebalancing in this direction seems too high for emerging Asia and China does not seem inclined to play ball.
The market is pricing in a 3.5 percent appreciation of the yuan over the next 12 months. Yet, if China opts only to allow incremental yuan appreciation, other Asian central banks will likely be emboldened to keep their currencies in check.

Indeed, some other Asian countries are resisting dollar depreciation through intervention. And as they balance their own reserves, some of these intervention dollars are recycled into euros, putting further upward pressure on the single currency. The United States will probably be impervious to euro zone discomfort. With jobless numbers rising and mid-term elections next year, the key for President Barack Obama must be job creation and that requires a weaker dollar.

More pain for the euro zone.

The foreign exchange market will deliver re-balancing, but in the short term, the heavy lifting will continue to be done by the euro. The all-time high will become the target. The euro zone will undoubtedly think this is unfair, but for the market it is the line of least resistance.


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