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• EURO
• FOREIGN EXCHANGE
• FOREX
• US DOLLAR

• COMMENTARY
• By John McCarthy

The race to the bottom that the dollar and the euro embarked on in the aftermath of the 2008 financial crisis now has become a race to the top.

And despite the constant chatter of the dollar’s resurgence and the restoration of U.S. economic dominance, it’s the euro that seems to be winning.

If that sounds incongruous against the euro zone’s continuing economic woes, another look at the past four years might help to make some sense of it.

In March 2009, the U.S. mortgage crisis was subsiding and policymakers turned their attention toward trying to restore growth. Thus the dollar came under continuing pressure from aggressive rounds of “quantitative easing” bond buying by an increasingly interventionist Federal Reserve. Not long after that the economic and political travails of Greece, Ireland, Portugal, Spain and Italy put the efficacy of the euro project into question. The end result was that both currencies sank against the rest of the world.

Now the focus is on the dollar’s rebound. That’s perhaps not surprising given that the U.S. currency is the preferred benchmark for most of the world’s currencies. It also comes with a handy narrative dealing with long-awaited economic improvement and tightening labor market conditions. Bond yields have crept higher as talk takes hold that the Fed is preparing to taper its bond purchases. Energy independence, improving home sales, even evidence of some manufacturing “onsourcing” all add to the improving outlook here.

But a closer look will reveal that most of the dollar’s gains against the yen, the Australian and New Zealand dollars, the Mexican peso, the South African rand and other emerging-market currencies have been matched and in some cases exceeded by gains in the euro against the same basket of currencies.

Why is this so?

I’ve heard of no analyst crawling from under a rock and calling for a rapid turnaround in the euro zone or an immediate end to the fiscal crisis there. No, you have to consider how the financial landscape is changing from what prevailed after the crisis. You’ll note that although these changes are being partly influenced by events here in the U.S., so much of the catalyst for the dollar’s and euro’s rebound originates in other regions.

The turning point came last summer when European Central Bank President Mario Draghi vowed to backstop the European periphery’s embattled sovereign-bond marketswith the ECB’s balance sheet and immediately put a stake through the heart of the euro’s existential crisis. The single currency stabilized as the threat of a euro breakup receded. This also put an end to much of the talk of global financial Armageddon and the overall failure of capitalism. The focus in world markets slowly returned to relative and not absolute questions–and it seems the market has concluded that in most cases it was the euro that was the most undervalued.

What followed next was the election of a new Japanese government led by Prime Minister Shinzo Abe, the commencement of “Abenomics” with its centerpiece of aggressive inflation-targeting monetary policy, and the end of safe-haven inflows into the Japanese money markets. Thus the yen fell as short-covering intensified. But while dollar/yen grabbed the headlines, the euro’s rise against the Japanese currency exceeded the dollar’s rise by almost 5%.

Now, investor concerns have shifted to the health of the Chinese economy, which has in turn put commodity bloc currencies under heavy selling pressure. The leaders in that particular selloff have been the Australian and New Zealand dollars, whose appeal has been further undermined by rate cuts and central-bank interventions. But the resulting rally in euro/Aussie has been greater than the fall in Aussie/dollar.

Meanwhile, the prospect of a Fed pullback has spooked bond markets around the world. This has filtered through to the emerging-market world, whose currencies are under renewed pressure. Commodity and labor concerns in South Africa have extended that currency’s slide. Again, the euro recorded gains along with the dollar against much of the emerging-market world.

Two of the main outliers in this trend aren’t insignificant currencies: the Swiss franc and the pound. It has been less clear that these two have dropped more against the euro than the dollar.

Still, the overall picture is one of a European currency that is at least holding its own against the dollar.

It’s worth remembering a line from Ecclesiastes: “The race is not to the swift, nor the battle to the strong….time and chance happen to them all.”

In this case the dollar may be swifter and stronger but it hasn’t necessarily won the race. The yen, Aussie, kiwi, peso and rand stories will help determine the race’s outcome as well. Sadly, a stronger euro, achieved in this case by “time and chance” represents an unwelcome outcome and will likely delay any prospect of brighter economic forecasts from Europe any time soon.

But that’s a story for later.