As warnings season approaches an end and the actual earnings season nears, a number of companies have blamed their sales and earnings shortcomings on the economic slowdown not only in the U.S., but also in Europe.
Adding to the woes of U.S-based multinationals has been the weakness of the euro. Recently, the
National Association of Manufacturers in the U.S. complained that the current strong dollar policy being upheld by the government is hurting U.S. exports. In effect, desire is growing both in the U.S. and abroad to support a stronger euro.
The euro most recently has been trading in a range between 84 cents and 86 cents. This is the range it was in last fall when the
European Central Bank tried several times -- unsuccessfully, as it turned out -- to boost the euro by selling dollars and buying euros. The first of those attempts, on Sept. 22, was a coordinated intervention that included the U.S. and the
Bank of Japan. The recent slide back to the current range has sparked expectations that the ECB may intervene once again.
TheStreet.com spoke with
Jason Bonanca, a currency strategist at
Credit Suisse First Boston, about the possibility of a euro-supportive intervention into the currency markets, how that might affect the currency markets themselves and the spillover effects such a move could have on U.S. corporate profits as we head into another earnings season.
TSC: There's been a lot of talk recently about an intervention into the currency markets in support of the euro. What are the chances that this might happen, especially after the Swedish Riksbank's
intervention on Friday? Bonanca: We feel that the chances are extremely small that such a thing would happen. We feel that the Riksbank intervention does virtually nothing to alter that view. The reason we think that is because the
European Central Bank, contrary to the position they had on monetary policy back in September, when they first intervened with the U.S. to support the euro, has exactly the opposite position now. They're easing policy now instead of tightening policy, as they were then.
Remember that back then, the ECB was increasing interest rates with the express intention of supporting the currency, saying that they were concerned about the currency's impact on inflation on a forward-looking basis. But now it's quite different. They seem to be more concerned with the long-term growth consequence than on inflation, and hence they're easing interest rates.
For a central bank to buy their own currency at the same time they're easing interest rates is the same thing as stealing from Paul to pay Peter. It is ridiculous because what implicitly is happening is ... you're printing money by easing interest rates, and then you're buying it back through the foreign exchange markets. This would be incredibly harmful to the ECB's credibility, which is really not something they can afford right now. And no major central bank has done such a thing with any degree of seriousness, outside of countries with fixed exchange-rate regimes.
In addition to that, we feel that one thing the ECB would like to do in the case of an intervention is to intervene with the
Federal Reserve, if at all possible. There are a couple reasons why we think that's not going to happen, either.
First of all, the Fed, because of the fact that the ECB would be doing one thing and saying another, will not want to be involved in this operation because it would be condemned to fail. Number two, the people that really do formally hold the keys to foreign exchange policy in the U.S. are at the
Treasury. This administration has pronounced itself generally not in favor of intervention in several instances, including after [the last coordinated attempt at intervention].
So we think it's a big no, and should the ECB undertake such a silly operation -- and we assign a probability that an intervention would take place of under 10% -- that investors would be best counseled not to ride the euro up and instead take advantage of selling the pop.
TSC: Let's just say the ECB did attempt a euro-supportive intervention. What effect would it have? Bonanca: I think that it might produce an intraday bounce, it may even produce enough fear in the market that the euro could get a bit of a rise over a short period of time, but we feel that within days, maybe weeks, that the euro would rapidly come off. This would be very negative for the ECB's credibility and would seriously impair the market's capacity to take them seriously as a mature central bank, because that would be just foolishness.
TSC: Where do you see the dollar and the euro going to in the near and longer terms? Bonanca: In the very near term, the euro has gotten a bit of a bounce here, and this could bring us up to the top of the downtrend. There seems to be a range that the euro has been following, but it's downward-sloping. And given the fact that we've seen some weakness in the United States, some concerns about the relationship between the U.S. and the [European Union] and some of the market chatter about the recent [National Association of Manufacturers] statement, that might well support the euro at these levels.
Unfortunately for the euro, the forward-looking cyclical picture is pretty tilted toward dollar strength, in our view. While we think that the Fed has plenty of room to ease during the summer, it is becoming increasingly clear that the end of the easing cycle is not all that far away. We have fiscal expansion coming up on us in the fall, which in and of itself is a dollar positive. And then once the Fed stops easing and passes the baton on to fiscal policy, that also would be dollar supportive.
The picture is quite the opposite in Europe. The ECB seems only to have begun easing, we're not quite sure how long this is going to go and you don't have the kind of fiscal stimulus that you have in the States to redress that. As a result, we just lowered our European growth forecasts to 1.9% this year, down from 2.3%. And it looks as if the euro area is not going to have an easy time of beating U.S. growth this year. It seems like a possibility that the U.S. could even beat the Europeans, even after having gone through this incredibly difficult period.
One thing that led us to lower our growth forecasts was some statistical work we did a few weeks ago that shows strong equity reflows back into the United States, via the sales of European equities that were acquired for M&A activity through equity swaps. That seems to have a positive impact on the dollar for many quarters. On top of that, the forward-looking productivity trends don't look all that encouraging.
In short, we think that over the medium to longer term, the euro will likely remain under pressure.
TSC: The more pertinent insight for our readers concerns recent earnings warnings -- including big names like Sun Microsystems(SUNW) and Oracle(ORCL) -- that have blamed Europe for their weak earnings. How might a weak euro continue to hurt U.S. corporations? Bonanca: Obviously a strong dollar does not help the exporter base, nor does it help those corporations that have balance sheets with many currencies that they do not hedge. We would expect that unless the number of companies that are hedging that exposure increases, that we might continue to see some complaints about the level of the dollar. But we have yet to see indications that the euro is really all that cheap, i.e., a cessation of the European purchases of U.S. companies, and the commencement of U.S. purchases of European companies. Since we don't see evidence of that, we expect to see some complaining, which may elicit market movements on a short-term basis as people get nervous.
Investors may also worry that we may get enough pressure on the U.S. to change the [strong dollar] policy, but we really don't expect a change of policy or anything more to come out of it. Except to hear more companies complaining and having to suffer the trials of not hedging against their foreign currency exposure.
TSC: So in the long term, the weak euro will continue to hurt U.S. corporate earnings? Bonanca: Unless they're hedged. To be honest, in the spectrum of things that lurk in the dark corners of the U.S. economy, this is one of the things that is relatively less important. At the end of the day, exports for us are not quite as important as they are for many other economies. I don't think the bugaboo is really the level of the euro; the bugaboo is the health on the domestic investment and consumption front. That's what's going to be more important for U.S. companies than the level of the euro.
The euro certainly will not help. But remember that for importers, the weak euro is a boon. People who import inputs from Europe into their product, they're doing wonderfully. Their cost base is going down substantially.
Many companies that are being quiet right now are probably benefiting; we're just hearing from the ones that are hurting. People who are happy don't scream as loudly as people who are miserable.
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