Wall Street got a shot of good news in the midst of a disappointing week as the dollar strengthened following votes against a European Union...
NEW YORK — Wall Street got a shot of good news in the midst of a disappointing week as the dollar strengthened following votes against a European Union constitution in France and the Netherlands.
The purpose of the constitution is to formalize the political union of the 25-member bloc, and the 12 nations that share the euro currency. It would streamline decision making and create a framework for market integration that many hope will energize Europe’s flagging economy. Analysts say the economic landscape won’t materially change if the EU constitution is not approved. But in the near term, the perception of a weakening euro is good news for the U.S. market.
“The thought that the juggernaut called the European Union is being slowed by the rejection of the constitution is probably more myth than reality, but on a short-term basis it creates more confidence in the U.S. markets,” said Joseph Battipaglia, chief investment officer at Ryan Beck in Philadelphia. “When you contemplate, as an American investor, the notion that international investors need to be regular buyers of U.S. securities, to have uncertainty now emerging out of Europe … that’s a good thing.”
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The lift in the dollar might have been difficult to discern during a week when the major indexes sagged. But the turnaround is a dramatic change from six months ago, when U.S. investors were fretting over the nation’s rising deficits and the steep declines in the dollar. There was even some fear that Asian central banks — big buyers of U.S. Treasurys — might hold more of their reserves in the euro, particularly as it rose to an all-time high of $1.3667 against the dollar at the end of last year. A euro bought just $1.2217 yesterday.
Now, with the constitution’s fate unclear, there’s a growing perception that when it comes to political unification in Europe, the shared currency may be as far as it goes. That would leave the euro as an “orphaned currency,” more vulnerable than it would be if it was backed by a national political structure, said Richard Batley, European economist with Schroder Investment Management in London. Historically, multinational monetary unions have broken down over time. The euro’s depreciation may reflect worry about that possibility, he said.
“The market is moving toward pricing in a very tiny chance of an EU breakup. That would be a cataclysmic event,” Batley said. “So now there’s a slightly higher risk premium associated with all euro-denominated assets.”
The European Central Bank had been keen to establish the euro as a reserve currency. But now the political impasse among the member nations and the continent’s general economic malaise is contributing to a sense of crisis in the Eurozone, Batley said. Against that backdrop, there is some danger of investors being carried away with a sense of pessimism.
“The euro doesn’t feel very much like a reserve currency at the moment,” Batley said. “When you’ve got a currency where the question is even considered, what would happen if the currency union should fall apart, that’s negative. That’s a question the U.S. dollar hasn’t faced since the 19th century.”
Most analysts believe the euro is here to stay, however, and not everyone is convinced the EU’s stumbles on the way to ratifying its constitution are necessarily negative. On a longer-term basis, it’s all about efficiency, productivity and fiscal responsibility, and that race continues to be played, Battipaglia said.
But while the unanswered questions will likely create volatility in the short term, analysts say the fundamental story in Eastern Europe remains positive. And for Americans whose portfolios are over-invested in domestic stock, this could be a buying opportunity.
“On a valuation basis, European stocks are more attractive than U.S. equities right now. They’re both reasonably attractive, but European stocks slightly more so,” said Aaron Gurwitz, portfolio strategist for the private investment management division at Lehman Brothers, which recommends investing half your equity portfolio overseas.
“This actually is a better time to consider that, because the currency price at which you’re buying European stocks and bonds is better right now. The euro has taken quite a hit here,” Gurwitz said.
But it would be a mistake to think the currency moves of the past week are permanent, or that the dollar’s newfound strength will take it straight up, Gurwitz warned. The factors that have kept the dollar under pressure still exist.
“We’re running a trade deficit upwards of 6 percent of our gross domestic product, that’s a huge number as these things go, and nothing that happened in France or Holland changed that,” Gurwitz said.
“The difference between what we borrow and what we save as an economy is very large. So we’ve seen what may be a prolonged pause in the downtrend in the dollar, but I don’t know that we’ve seen the end of that process.”
European economist with Schroder Investment Management