Many years ago, I worked in the stock market. Then later on, I transitioned into the currency market. I had to learn that there were certain things that could be interpreted as “bad” for stocks that could be “good” for currencies and vice versa.
For instance, when a central bank starts hiking interest rates, it’s generally seen as a negative thing by stock investors because the central bank is deliberately trying to slow down the economy (even if for good reason), which will slow down corporate earnings — which will take stock prices lower eventually.
Yet in the currency world, normally, interest-rate increases are a good thing for a country’s currency. You see, some of the biggest currency traders/investors tend to be “yield seekers.” They want to earn the highest interest-rate yields on their currency as possible.
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Therefore, you can imagine how the herd of investors can pile into a currency that has ever-rising interest rates over time. The massive buying in the currency pushes the currency higher over time, too. So that’s why, generally speaking, that higher rates are a great thing for a country’s currency.
But there’s always an exception to generalities isn’t there? Nothing is ever “cut and dried” in the financial markets. And I believe that we’re about to see one of those exceptions happening very soon in Europe.
European Central Bank (ECB) President Trichet said last week that they would have “strong vigilance.” In times past, that’s his “code word” for saying that rate hikes are just around the corner … especially by using that word “strong.”
Therefore many traders and investors are thinking that the ECB could hike interest rates as soon as next month to deal with the rise of inflation (that if left unchecked could spiral out of control very easily).
Normally, this is a good thing for a country’s currency. However, this time I believe it’s one of those exceptions and here’s why …
The eurozone is made up of many countries. Some large ones like Germany and France and some little ones like Portugal, Greece, etc.
Now if interest rates are hiked in Europe soon (and I believe that they will be), then it will be very hard for Portugal, Spain, Greece, Ireland, etc. to finance their debts at ever-increasing interest rates. Their payments will go up and they simply can’t handle that.
Germany and France will be fine. But these other countries will have their wounds reopened as interest rates go back up.
But that’s just one problem. Right now, I feel that it is even worse because of the timing of things. What do I mean? I’m talking about the rise of the price of oil and
the rise of interest rates in Europe.
You see, the more the price of oil rises, the more it costs economies to get the same level of output. It eats into the pockets of consumers, too.
The more they have to put in their tank, the less they can spend elsewhere in their country.
In fact, some estimate that here in America that for every one cent that the price of gasoline goes up, it takes $1 billion of discretionary spending out of the U.S. economy. Just a one-cent rise.
Imagine what that does over in Europe which always has higher gas prices than we do. California has $4 a gallon gasoline right now. But there are some parts of Europe that have the equivalent of $6 a gallon gasoline right now.
The bottom line is that rising oil prices act like an ankle weight upon a runner. Sure, they might be able to run for a little while … but they are going to get tired and worn out faster and will need to rest more often. Well, just like that’s a drag on the runner, rising oil prices are a drag on an economy.
So just imagine how well these debt-laden countries are going to deal with the higher costs of oil/gasoline and
the rise in the cost of money through interest-rate hikes.
It’s not going to be a pretty situation. It’s going to hurt these countries in the eurozone and that will eventually have a negative effect upon the euro too.
In time, and it won’t be long, it will bring down the euro against the dollar.
About the Author: Sean Hyman
Sean Hyman is a member of the Moneynews Financial Brain Trust. Click Here
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