With the Fed set to make further rate hikes and the ECB continuing its love for Quantitative Easing (QE), we examine the effect these contradictory monetary policies are likely to have on organizations reliant on the near-term Dollar/Euro spreads.
“A consensus is growing that escaping this low-growth, low-inflation environment will require a rebalancing between monetary, fiscal and structural policies.” Very wise words from Bank of England Governor Mark Carney in a speech last September. The challenge is that since Carney uttered these words, a highly divided global political climate has led to different regions and countries creating diverging monetary policies in an attempt to stimulate growth.
And nowhere is this divergence more evident than across the U.S. and Europe. Back in November, the U.S Fed implemented a second-rate rise of 0.25bp. In contrast, the European Central Bank (ECB) has gone full steam ahead with its QE bond-buying binge. The net effect has been a continual weakening of the euro against an increasingly stronger dollar. On top of this, Trump’s infrastructure spending drive, coupled with the likelihood of further rate hikes down the road from the Fed, should strengthen the Dollar further against the Euro in the near term.
For U.S. firms with operations across Europe, this situation presents numerous challenges as well as opportunities. With a strong dollar, as long as demand remains high, imports are likely to be cheaper. On the flip side, if the imports start to undercut pricing, then firms will subsequently lose business. As a result, there will be a much bigger onus on financial officers to monitor for currency movements on an almost daily basis. Currently, any U.S. company with operations in Europe currently experiencing a high demand for its products, will be getting less out of their overseas sales. Any financial officer working for a firm in this situation could be faced with having to recalibrate their earnings forecast.
All of this points to the fact that CFOs and financial directors need to be up to speed with geopolitical events, particularly as a central bank’s monetary policy decision making could alter at any stage. The rise of right wing populist movements across France and Germany could very well threaten the existence of the Eurozone. Should these party’s come to power, the ECB may well take further action – similar to the measures enforced by the Bank of England post Brexit. If this materializes, businesses will need to adjust accordingly. But for the time being, for any prominent U.S. exporter operating in Europe, the Euro’s weak stance against the Dollar is something to grasp with both hands. Finance officers that grab the opportunity now, while keeping a keen eye on the near future, will be best positioned to avoid any, as Mark Carney puts it, further “economic post-traumatic stress disorder.”