Dollar Sellers - Euro Buyers

It started as a little domestic problem among low quality mortgage lenders and in the end developed into a fully-fledged global crisis. The implosion of the sub-prime mortgage industry prompted investors to worry about asset-backed securities and about the banks and funds that owned them. From there they got to worrying about other risks.

They worried about their own situations because nobody knew where the bodies were buried; there was no easy way to measure the real value of some of these mortgage assets. Banks quickly cut back on their lending, hoarding cash in case they needed it to patch up problems of their own. US mortgage companies went out of business and Northern Rock had to be bailed out by the Bank of England. The world was in the grip of a credit crunch.

At the epicentre the Federal Reserve pumped out liquidity and cut the discount rate. A Federal Funds Rate cut loomed. The Bank of England abandoned plans to raise Sterling interest rates. The Dollar fell, the Pound fell and the Euro sailed serenely on. In mid September it touched its highest level for Dollar (or a record high if you ignore the Euro's predecessor, the ECU).

With the FED rate now being cut by 0.5%, investors are much less likely to invest in the US Dollar as the return (yield) is less and therefore the Dollar is weakening.

There are a couple reasons for the Euro's success. When the liquidity shortage first made itself felt the European Central Bank was quick to shell out cash to the money markets. More important than that though was the tough talk. The way they told the story in Frankfurt, the ECB boys had always intended to raise Euro interest rates and they were not going to be put off their stride by a little thing like a global liquidity crisis. Investors are always impressed by stuff like that and they kept faith with the Euro.

Of course it is by no means certain that Euro interest rates will go up, whatever the ECB Council says. The market picture changes from day to day and any number of events could divert the ECB from its current strategy. Until then, however, the prospect of a Euro rate hike will tend to give the Euro an advantage over the Dollar, especially as it is all but certain that the US economy will soon feel the negative effects of the sub-prime-related fallout. It means that the weak Dollar game is still playing. Most analysts were looking for the Euro to reach $1.40 but on September 21st we saw it hit an all time high of $1.4120 and after a round of consolidation up there they expect it to move higher still.

For Americans buying into European real estate this is a concern because it pushes up the Dollar cost of investments.

The cautious investor will want to do something to protect against this and the solution is to buy the Euros 'forward'. Instead of waiting for completion day to arrive and taking pot luck with the exchange rate it is possible to fix a price today, even when there are still months to go before you will actually need the money. Pay a percentage deposit, agree an exchange rate and set a day for the transaction to settle. After that there is nothing to do until settlement day arrives. At that point the balance of the Dollars are handed over and the Euros go to your account.

A forward purchase of Euros sorts out your exchange rate risk without crippling your cash flow in the meantime. It's worth a look. Don't be dismayed if your regular bank has no idea what you are asking them for. Go to a currency specialist firm. They handle trades like this all the time and you'll find people there that know what they are talking about.

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