Yesterday's rally in the domestic equity markets was, on it's face, heartening. European leaders seemed to reach for "shock and awe" measures over the weekend, restoring a measure of confidence for the short-run. As the day wore on, however, we couldn't help but notice that what began as a concurrent rally in the Euro largely fizzled. After bouncing all the way back to the 1.3000 level versus the US Dollar (up from about 1.2750 on Friday), the market faded back to close at 1.2731 -- making for slender 0.2% gain on the day. This could be a cause for concern in some circles considering that the rhetoric out of the EU over the weekend included a pledge that the Euro would be defended.
Count the analysts at Morgan Stanley as unimpressed. A post on "The Money Game" blog site quotes the Wall Street bank as commenting:
Overall, while fiscal policy might be on a more credible path the biggest threat to the euro is now coming from monetary policy. We believe we are not far away from a point in time when the ECB starts printing and effectively monetising euro area debt. We revert back to our “punish the printer” theme, where quantitative easing remains negative for a currency.
The above comes at a time when the US economy is in good shape and growth is surprising to the upside. While the Federal Reserve used the printing press a year ago we expect them to begin reversing this process through the summer, while it might be that the ECB is boosting its money supply.
It is likely that any rally in the EUR will be relatively shallow. The combination of fiscal credibility and a likely move to quantitative easing should put pressure on EUR to depreciate. Near term, there may be a relief rally, due to positioning and a removal of the extreme negative tail risk, but the lower trajectory remains in place.
