Better make a Europe trip while dollar rules

A long time ago, in a financial galaxy far, far away, it looked like the US dollar was going to be worth more than the euro. It was called ‘March’.

Since then, though, the stronger dollar seems to have hurt the economy enough that the Federal Reserve will probably put off raising rates like it’d been hinting it would this June. And that, together with a stronger-than-expected recovery in Europe, has made markets wonder how much higher interest rates really will be here (in the US) than they are there (in Europe) with the dollar’s monster rally going into reverse as a result.

So, if you can, take that European vacation you’ve been thinking about right now while it’s still cheap. Things are still pretty cheap in Europe for Americans, but maybe not for long.

Now, up until a few months ago, it’d been a simple story. The US economy was doing well enough that it looked like it would start raising rates soon, and the rest of the world was slowing down enough that it was cutting them.

Europe, in fact, had finally gone beyond that by not only cutting interest rates into negative territory, but also buying bonds with newly-printed money. That meant investors would be able to make more money by holding their money in dollars that would probably start paying interest rather than in euros that wouldn’t — so that’s where people moved it, and, in the process, pushed the value of the dollar up as much as 14 per cent.

But that was before a litany of disappointing data made the US recovery look like much less of a sure thing. A big part of it was that the stronger dollar has made it harder for American companies to sell exports overseas or compete against imports at home. Another part was that our winter of discontent about all the snowstorms we got made it harder for shoppers to leave home or construction workers to build them.

And the last part was that lower oil prices seem to have hurt business investment more than they’ve helped consumer spending. Indeed, retail sales were just flat in April. Add it all up, and the economy probably shrank at the start of the year and probably isn’t growing much faster — the Atlanta Fed estimates it at 0.9 per cent — right now.

That’s why, as former Fed Vice Chair Donald Kohn says, it seems all but certain now that the Federal Reserve won’t start raising rates until September or December. Why is that so important?

Well, it’s not so much the timing as was that timing tells us about the Fed that matters. A central bank that’s willing to wait until the end of the year for lift-off is one that might go slower once it does happen.

Interest rates, in other words, might not get as high as markets had thought they would a few months ago. At the same time, cheaper oil and the ECB’s bond buying have gotten Europe’s economy growing a little more — although those last three words might not be necessary — so that its unconventional policies might not last as long as people had thought. The result is that the dollar hit a four-month low against the euro. In all, the dollar has fallen 7 per cent from its March peak.

But it’s worth keeping some perspective here. Even with its latest dip, the dollar is still a lot stronger than it has been any other time the past four years. So if you were thinking of hopping across the pond, it’s still a good time to go ... and it might not get any better.

That depends, though, on whether the Fed thinks the weak GDP numbers or the good jobs numbers are a better gauge of the strength of the economy.

Now, it doesn’t make sense that jobless claims would fall to a 15-year low — and, as Bill McBride points out, an all-time low once you adjust for the size of the labour force — while the economy has supposedly stopped growing, but that’s the world we live in. So if the Fed decides that these jobs numbers, rather than what can be noisy GDP ones, tell the real story of the recovery, then it might surprise us by raising rates sooner and faster than expected — sending the dollar back up.

It would also go up if the ECB really does decide to keep buying bonds, like its chief Mario Draghi says it will, until there’s nothing resembling a doubt that its recovery is real. That said, even if these did happen, the dollar might not have a lot left to go up. It’s still done a lot of that.

That sound you hear is the economy breathing a sigh of relief that the dollar probably couldn’t go much higher. And your travel budget saying darn. Take that Euro trip this summer.

Washington Post