HIFX Report: The Euro and The Dollar

Posted by — January 22, 2006

HIFX Report: The Euro and The Dollar

What has caused the Euro to fluctuate against the Dollar and what does the future  hold?During 2005 the Euro lost over 14% of its value against a resurgent US Dollar. This move meant that had you purchased a property priced at €200,000 in April 2005, you would have paid $260,000 (22nd April  05 - 1.3000). Would you have purchased that same property in November you would have paid 236,000, a saving of $24,000 (4th Nov 05 – 1.1800). So what caused the USD to appreciate so much?  And will it continue to do so through 2006?

There are many underlying issues as to why the USD was so strong in 2005, however, the primary reason for it’s appreciation was the continuing expectation that interest rates would go higher. At the start of the year interest rates stood at 2.25% and by December 2005 finished the year at 4.25%. The net result of these successive hikes meant that the attractiveness of the currency to overseas investors - due to higher yields - increased significantly and consequently helped traders and investors look past the U.S’s bulging trade and budget deficits. The U.S was also starting to show strong signs of economic growth and stability. Housing prices were on the up and consumers appetite for spending was near all time highs; both positives for the US. 

At this stage it is also important to evaluate the economic climate within Europe during 2005.  Germany, Europe’s largest economy, had spiraling unemployment levels and the manufacturing sector was crippled. This acted by in large as a drag on the European economy. Furthermore, both Italy and France were experiencing economic uncertainty, and although the European Central Bank (ECB) raised rates for the first time in 29 months it was not enough to inspire confidence in the European Union.

So what lies ahead for 2006?  With the Federal Open Market Committee (FOMC) having given its clearest signal yet that the interest rate cycle is drawing to a close, attention will once again focus on the major structural imbalances which remain evident in the US economy. A swelling trade deficit (which stands at 6% of Gross Domestic Product) is a major concern to investors. Many realize that a weaker USD is one way to help rectify this imbalance.  In addition to this, the European economy seems to have weathered the storm and is showing the first signs of a recovery and of growth. The market expectations for European growth should increase the possibility for another 25bps rate hike from the ECB. In summary the year ahead promises to be another year for big moves in the currency markets and in particular EUR/USD.  This just heightens the fact that having a comprehensive purchasing strategy for your currency is all the more important.

Therefore, looking at the current levels a sensible strategy for someone buying property in the Euro zone would be to secure as much of the currency needed straight away – thus fixing the cost at the outset. If all the funds are not available, the exchange rate can still be secured by purchasing one or more “forward contracts”. This involves putting down a 10% deposit to secure the current rate of exchange which can then be held for up to two years. This way of buying currency is flexible and can accommodate changes in the time scale originally agreed – due to delays in the purchasing process etc. The worst thing to do is sit back and do nothing!

There are often many factors influencing the foreign exchange markets and because of this it is impossible to predict future rates of exchange with 100% accuracy. HIFX, however, are world renowned for their market views, and Reuters consistently rank them in the worlds top three most accurate currency forecasters. Although they cannot predict the future, the Private Client Consultants will implement a strategy, free of charge, to help you manage your currency risk as efficiently as possible.

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