The Hindu Business Line : Euro/yen: Time to sell?

The euro is near the all-time high it reached against the US dollar. Last week, it crossed $1.35, being just 200 pips away from the peak of $1.37 hit in end-2004. From that level, it fell below $1.2, but has since recovered steadily, with the pace of appreciation increasing in recent weeks.

The reasons are easily fathomed. After a prolonged period of languid growth, recessions and near recessions, the eurozone, particularly Germany, is on a sustained growth path. The area's GDP is comfortably in the 2 per cent plus range. Germany's employment picture is continuously improving. Its business confidence (IFO) and investor sentiment (ZEW) indices are well into positive territory, unaffected by the tough noises from the European Central Bank (ECB) on interest rates. Euro rates, have, in fact, already been raised to 3.75 per cent from a low of 2 per cent and going by the utterances of ECB President Mr Trichet and his colleagues, there is more to come.

Moving forward

In contrast to the harried dollar, the euro has got everything working in its favour. The eurozone economy is moving forward, while America's growth is turning tepid. The euro's interest rate outlook is assuredly for higher rates, but that of the dollar is clouded, with the market (and possibly the Fed, though it is not saying so) divided on whether the next move will be down or if rates will be kept on hold for some time. Few think rates are headed up.

The euro's rapid rise and strength on the foreign exchanges, therefore, has a rational basis - growth combined with the hawkish stance of its central bank. Also, unlike the US, the eurozone does not suffer from a trade deficit problem.

The euro has a marked advantage over the Japanese yen as well. Despite dollar interest rates being more than those of the euro, the single currency has held its own against the greenback. So what chance does a near-zero interest rate currency like the yen have against the euro? Sure enough, the euro now buys over 160 yen, up from about 100 yen some years back.

Will the euro's bull run continue? Clearly, the market will be chary of driving it up beyond the existing top of $1.37. Much of the euro's gains stem from an improving interest differential. If that prop goes, either because US prospects are re-rated or the Fed sticks to current interest rates, the euro could take a knock.

The Japanese economy, while still not out of the woods, faces far fewer question marks than the US. A speculator would be on surer ground wagering against euro/yen, which is carry trade driven, with ultra-cheap yen borrowing funding long euro positions.

Any unexpected event in global financial markets could see these trades unwind quickly and the yen spiral upward in no time.

Looks like a great opportunity for a contrarian position in euro/yen.

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