The past events shocked the ordinary situation of the currency markets as Switzerland dropped their fixed exchange rate to the Euro. This decision is a clear statement which shows in which way the value of the Euro is heading. Today I will explain how a fixed exchange can be realized in practice, which securities will benefit from the current decisions and what this means for our lives in Europe from a macro perspective.
There are mainly two different situations on the currency market which influence the value of a currency. The first situation occurs when more market participants want to buy a currency than sellers are in the market, this increases the value of the currency. Adapting this to Switzerland the swiss bank would increase the supply on the markets selling their Euro deposits to keep the price stable. The second situation is the direct opposite of the first one. More people in the markets would like to sell their Euros than buyers are interested, this circumstances decrease prices. In this case the swiss bank would buy the surplus in the market at their target price to stabilize the currency. The demand of a currency is correlated with the demand of investments like bonds since they can only be obtained in the bond currency. Going to the next part of this post it is important to understand that a high inflation reduces the demand of bonds in this currency and this reduces its overall value.
The ECB president unveiled a quantitative-easing programme of 60 billion euros per month until at least the end of September 2016 in a once-and-for-all push to revive inflation and the euro-area economy.
This means that investors are not willing to buy government bonds with the current risk profile so that European countries could not refinance themselves for a price they were able to repay in the future. This situation would lead to a default of those countries and wrack the Euro as a European currency. Draghi is extending the life of a already dead patient with cheap money which is pumped into the European economy, totally ignoring the powers of demand and supply. This creates artificial circumstances for all market participants and keeps states alive which should default by natural market rules.
As market players we can adapt to this totally new environment in the European market. More money for the same volume of goods increases prices what is called inflation. In this case a good idea is joining the stock market. Breaking down the complex mechanics to a simple rule means that that companies have to pay more for their commodities and increase therefore their prices, this increases their gross profit and therefore their account and the whole company value increases. More liquidity drives the stock market not only because of the supply chain but also because of the dropping interest in bonds. The inflation in this case burns the returns of low yielding bonds and investors search for substitutes, floating the stock market with extra money.
I am personally strongly invested in US companies for a few months right now with the outlook of a potent US economy combined with a weak Euro. I am not only benefiting from the US growth but also from the exchange rate which gives me additional returns compared to Euro stocks. At this point it is important to mention that there are definitely Euro stocks which will gain attention taking into consideration those who mainly sell their products across the world. The weak Euro reduces the purchasing price for foreigners and makes them more competitive in comparison to companies which produce in expensive currencies.
Euro bonds are right now definitely the wrong way to invest but any leveraged projects become more interesting. The money surplus will lead to even lower interest rates what makes even more projects viable which could not be realized under regular market conditions. Debt financed properties might get the attention of people who have resources to receive a loan. This demand will increase property prices and blow up a bubble in the property market, if the rents will not follow.
I would like to end this article with some facts for the everyday life from a birds eye perspective. First of all the consequences of Draghi´s decision hit savers in a very high extent. The huge devaluation of the Euro will wrack the whole retirement of the most Germans. Furthermore everybody who is working on a fixed contract will face increasing prices while having the same amount of money to spend. In fact the Euro zone becomes more competitive as a producer but I assume that this surplus will not seep in a significant way to the workforce. Leaving the Euro zone becomes more expensive. The good news is that having diversified capital in any form allows to benefit from the situation or at least offset the losses which are taken in Euros.
The swiss bank bet on this decision made by Draghi and they have won. While the Euro got bashed they did not buy any from the market so the Franc increased what has a negative influence for their export but it also made them avoid the losses which they would have taken from the devaluation of the Euro.