Upset by the Euro's Continued Strength? Blame the Central Banks

NEW YORK (TheStreet) -- Last Thursday I wrote that the recent actions taken by the European Central Bank would cause the euro to fall against the dollar.

I also wrote that hedge funds already had been betting on a fall in the euro against the dollar, which had resulted in a decline from about $1.393 in the middle of March to $1.36 just before the ECB announced its changes.

Guess what? The value of the euro did decline initially in reaction to the ECB's moves. As I wrote Thursday, "The early results: The euro plunged to a four-month low against the dollar after the ECB announced the package, falling 0.7% to $1.3503 from more than $1.36 before the central bank's rate cuts."

By Tuesday morning, however, the euro was trading around $1.355.

What happened?

Well, some analysts argued that investors (the hedge funds) had correctly anticipated the changes the ECB made and there was little room for further declines.

If one looks at other markets, however, it appears that not everything could have been discounted already by the foreign exchange market.

Yields on the sovereign debt of Spain, Portugal, and Italy fell after the ECB announcement on Thursday, and the spread between the yields on those securities and on German bonds of similar maturities have reached postcrisis lows this week.

Furthermore, the stock markets in these countries have risen by about 3% since the ECB announcement.

But, the value of the euro did not fall against the dollar as expected. Mario Draghi, president of the ECB, had previously indicated that he wanted the eurozone's currency to decline because this would help increase exports from the region and fuel faster growth.

So why hasn't the euro declined more?

One answer is that investors don't see the ECB's moves as being that much more expansive when compared to what the Federal Reserve is doing in the U.S.

Even though the Federal Reserve is "tapering" its open-market purchases of securities, it still bought $35 billion of securities in May and is supposed to purchase $25 billion in June.

These amounts are much less than the $85 billion per month the Fed was purchasing, but $35 million is not peanuts.

And, the ECB has not yet committed to "quantitative easing." Mr. Draghi has discussed the possibility of going to a policy of quantitative easing, but he has been very reluctant to commit to it. He appears to be exhausting all other courses of action before doing so.

So, what the Federal Reserve is doing still looks relatively "loose" compared with what the ECB is doing -- including the actions that the ECB took last Thursday.

Furthermore, investors believe Fed Chair Janet Yellen and other Fed officials are still poised to err on the side of too much easing rather than too little. And with the negative rate of growth in real GDP in the first quarter of 2014 and the fact that unemployment is not falling as rapidly as some would like, there is some concern that the Fed will stay on the "easy" side and keep short-term interest rates low.

Thus, the value of the euro has not fallen as much as perhaps some in Europe expected because of the continued easy-money policy of the Federal Reserve. The only reason this might change is if Mr. Draghi and the ECB decide to introduce their own brand of quantitative easing.

At the time of publication, Mason had no positions in currencies and bonds mentioned.

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This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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