The European Central Bank (ECB) began to discuss the prospect of quantitative easing in April 2014, when the euro traded for about US$1.35 to US$1.40.
In late January 2015, the ECB announced plans to purchase EUR60 billion (US$70 billion) worth of bonds each month until at least September 2016. The central bank started buying securities earlier this month.
Amid all this activity, the euro has retrenched to less than US$1.10, a slight pullback from recent lows of US$1.05.
This rocket fuel has propelled European equities to impressive gains, with the STOXX Europe 600 rallying by about 25 percent over the past year, easily outpacing the S&P 500’s 15 percent upswing. However, the STOXX Europe 600’s outperformance evaporates when translated into US dollar terms.
We expect the euro to weaken further against the US dollar over the next 12 months, driven primarily by interest rates. Although the yields on US Treasury bonds remain historically low, the securities offer a superior current return relative to paper issued by other governments in the developed world.
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The US 10-Year Treasury bond yields 1.87 percent, compared to the 0.5 percent current return offered by French bonds of the same duration and the 0.22 percent that the German government pays to borrow money for a decade.
Even more shocking, 10-year bonds issued by the Netherlands’ government sport their lowest yields in the 498 years since the trade-minded Dutch began keeping records.
US Treasury bonds even command a yield premium to paper issued by Italy, a country that has a debt-to-GDP ratio of 132 percent and, not long ago, was at the epicenter of the EU sovereign-debt crisis.
And earlier this month, the yield spread between 10-year US and German government bonds reached 1.86 percent—the widest differential since at least the 1980s.