EUR/USD – 2013 in Review

We were treated to a strong movement from EUR/USD over the course of 2013. The pair started the year at the 1.32 line.

Movement of EUR/USD in 2013:

2013 High – 1.3832 (October 25)
2013 Low – 1.2756 (July 9)

January and February were the months which showed the most volatility. During this time, the pair hit a high of 1.37 and a low just below the 1.30 level. Since late November, the euro has jumped over three cents to its current level of 1.3670.

Monetary Policy Decisions of ECB:

In January 2013, the interest rate on main refinancing operations (benchmark interest rate) stood at 0.75%. The ECB reduced this by 0.25% in May, to a level of 0.50%. In November, the ECB again reduced rates by a 0.25%, to a record low of 0.25%. The deposit rate held steady throughout 2013 at 0.0%.
The rate hikes were a response to continuing low inflation and weak growth which has affected the Eurozone. However, despite record low interest rate levels, inflation hasn’t picked up as hoped. The ECB has forecast inflation of 1.5% in 2013, well below the ECB’s target of about 2%. As for growth, the news is grim. The ECB expects the economy to decline by 0.4% this year.

What to expect in 2014:

The ECB is expecting better news in 2014, with the Eurozone economy expected to post growth of 1%. Inflation is projected to remain below the central bank’s target, with an estimate of 1.3%. So we can expect interest rates to remain low for the foreseeable future, as ECB head Mario Draghi has stated at many of his press conferences. What monetary steps can we expect from the ECB? The central bank could again lower its benchmark rate (perhaps less than a 0.25% cut, which would bring rates to zero). It could also opt to lower deposit rates into negative territory. However, the ECB has never taken this step before and appears to be reluctant to do so, as such a move could have unintended negative consequences.

2013 Highlights

Two members of the Eurozone, Greece and Cyprus, were hit hard by the debt crisis. In Greece, the government was forced to introduce harsh austerity measures which included layoffs and wage cuts for public workers. These steps were demanded by the IMF, EU and ECB (the “troika”) in order to reduce Greece’s budget. Greece has received some 200 billion euros in aid from the troika since 2009, and there was considerable opposition to extending more aid to Greece, particularly in Germany. During her election campaign, German Chancellor Angela Merkel went on record as saying that allowing Greece to join the euro was a mistake. However, the general consensus was that Greece could not be allowed to drift into bankruptcy and leave the Eurozone. There is hope that the country is finally turning a page, as the economy is expected to grow in 2014, after being mired in a recession since 2007.

In Cyprus, a severe banking crisis resulted in a near-meltdown of the country’s financial sector. Cypriot banks found themselves in trouble due to their exposure to Greece. A large portion of the assets in Cypriot banks were from Russian investors and depositors who took advantage of the country’s lax taxation and banking regulations. Many Eurozone members were concerned that a substantial amount of these funds were not legitimate. After intense negotiations, the troika agreed to provide Cyprus with a rescue package of 10 billion euros. As part of the agreement, a bank deposit levy on all domestic bank accounts was announced, and bank withdrawals were severely limited in order to avoid a run on the banks. However, the bank levy caused such a furious public reaction that this measure was shelved. The agreement between the troika and Cyrus resulted in a restructuring of the country’s financial sector and the closing of the country’s second largest bank.

In Germany, national elections were held earlier this year. Chancellor Angela Merkel was elected to a third consecutive term. However, her CDU party fell slightly short of a majority in parliament. After weeks on negotiations, the CDU has entered into a coalition agreement with the Social Democrats. The CDU is expected to retain the finance ministry, which would leave Wolfgang Schauble as the country’s finance minister. Schauble is known for his tough stance towards bailout for struggling Eurozone members, so Germany will likely be stingy with the purse strings if future bailouts are needed.

In the US, the Federal Reserve announced last week that it would begin tapering its QE program by $10 billion a month, commencing in January. This will reduce the Fed’s asset purchases to $75 billion every month, comprised of $40 billion in Treasuries and $35 billion in mortgage bonds. The announcement came as somewhat of a surprise, as most analysts had expected the Fed to hold off on any QE reductions until early next year.

In its dramatic tapering announcement, the Federal Reserve was careful to separate tapering from rate hike expectations. Fed chairman Bernard Bernanke stated that interest rates are likely to remain low even after the unemployment rate drops below 6.5%. Previously, the Fed had stated that it would start to consider rate increases when unemployment fell below this level. Bottom line? With the US unemployment rate at 7.0%, it could be a while before we see higher interest rates in the US.

Earlier in the year, Republicans and Democrats held the government hostage and played a dangerous game of brinkmanship that almost resulted in a sovereign default by the United States for the first time in its history. After weeks of finger pointing and political brinkmanship, Congress finally got its act together and voted to fund the government and raise the debt ceiling. The shutdown, which lasted for over two weeks and temporarily threw hundreds of thousand of federal employees out of work, is estimated to have cost the economy $24 billion. The cost of the debt crisis is harder to quantify, but has certainly eroded faith in the US economy.This was underscored by a warning from Fitch Ratings, when the agency put US debt on a negative watch. Fitch stated that the crisis had cast doubt over the credit of the United States and had undermined confidence “in the role of the US dollar as the pre-eminent global reserve currency”. The Republicans were the losers in this episode, as they failed to obtain any concessions regarding the Obama Health Care Act and were blamed by most of the public for precipitating an unnecessary political and fiscal crisis.

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