The concept of the carry trade, where money is borrowed at low interest rates in one region and invested in higher-yielding regions, is as old as civilization itself. Historically, this trade has been epitomized by ancient traders who carried wheat from Egypt to Rome for profit. Today, the same principle applies in financial markets, with the Yen having been a dominant funding currency for years. However, the Euro is now emerging as the new preferred currency for global carry trade due to a confluence of economic weaknesses in the Eurozone, misaligned interest rate expectations between the U.S. and Europe, competitive Latin American (Latam) currencies, and growing political instability in France.
The Eurozone’s Economic Challenges
The Eurozone is currently the only major Western economy with a significant unemployment problem. For example, Germany’s unemployment rate has surged by 1.1 percentage points to 6%, far surpassing the threshold set by the Sahm rule, which is often used as an early warning for recessions. In stark contrast, Mexico and Japan are experiencing full employment, and the U.S. has maintained an unemployment rate of around 4% despite accommodating at least six million immigrants over the past two years. The rise in Germany’s unemployment underscores the broader economic challenges facing the Eurozone, which have been exacerbated by rising bankruptcies in France. Over the past 33 months, French bankruptcies have steadily increased, setting new records each month. Unlike in the U.S., where companies can often restructure and survive bankruptcy under Chapter 11, French companies rarely recover once they enter bankruptcy court, highlighting the rigid and unforgiving nature of the Eurozone’s economic environment.
In terms of inflation, the Eurozone has managed to maintain a relatively stable inflation rate, with figures hovering around 2% for ten consecutive months. This contrasts with Japan and Mexico, where inflationary pressures are accelerating. Looking ahead, the Eurozone is less likely to experience another significant price shock. For instance, if the Russia-Ukraine conflict were to end, the resulting stability in energy prices would alleviate inflationary pressures. Additionally, potential U.S. tariffs could redirect cheaper Chinese goods to the Eurozone, further stabilizing prices. Moreover, fiscal policies across the Eurozone are expected to tighten as member states return to Maastricht deficit targets, ensuring greater price stability in the region.
Interest Rate Expectations: A Tale of Two Central Banks
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