Are Europeans Considering Intrevention in FX?

Comments from European Union’s Commissioner for Economic and Monetary Affairs Joaquin Almunia, that the Euro group will discuss euro’s appreciation at the upcoming G-7 meeting this Saturday in Istanbul, sent the single currency tumbling for more than 50 points in a matter of minutes at the start of European FX trade.

The latest statement from Mr. Almunia following on the heels of similar sentiment expressed by French President Nicholas Sarkozy at the G-20 summit earlier this month indicates that European fiscal authorities are becoming increasingly concerned about the relentless rise of the euro against the dollar. The currency has appreciated more than 16% since reaching a low of 1.2455 against the greenback in early March.

Despite euro’s sharp rise, prospects for recovery in the Eurozone in H2 of 2009 may actually be stronger than those of the United States. Yesterday’s surprisingly robust German unemployment numbers which declined by -12K versus market expectations of a 20K rise were the third consecutive monthly decline in joblessness indicating that labor market conditions in EZ largest economy have stabilized. Contrast that with disappointing US unemployment data as ADP report forecast another -250K in job losses for the month of September.

With oil price rebounding above $60/bbl and demand from China continuing to escalate, European exporters have been able to overcome the barriers of high exchange rates to supply Middle East and Asia with capital goods for those region’s massive infrastructure build outs. On the other hand, US manufacturers have had only limited success in pressing their weak currency advantage on the global stage. If yesterday’s surprisingly weak Chicago PMI data foreshadows today’s ISM Manufacturing report the divergence between EZ and US economic condition will become even more pronounced.

Nevertheless, despite the relative economic strength of the region, EZ officials are worried about the ascent of the euro, and today’s not so subtle warning from Mr. Almunia suggests that officials have decided to preempt any attempts at a runaway market. The EZ authorities are clearly concerned that a move past the psychologically important 1.50 mark could trigger a wholesale liquidation of long dollar positions and open the way for a test of all time highs of 1.6036 set in July of last year. Therefore today’s comments may be the start of a verbal intervention campaign to slow down the units rise, especially in light of possibly another weak US NFP number on Friday which would put further downward pressure on US rates and make the dollar even more vulnerable to carry trade flows.

We doubt that G-7 officials will actually offer any specific communiqué on exchange rate movements, given the group’s preference not interfere with market activity. However, Mr. Almunia’s attempts at jawboning maybe the preview of things to come if EUR/USD continues its one way trip north and the rhetoric will likely become much more aggressive if the pace of appreciation quickens.