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Continued: To hedge or not to hedge on the euro

  • Article by: CHRIS FARRELL
  • Last update: November 27, 2010 - 10:15 PM

Q We're leaving for Italy in April and we heard about the Fed's decision to help turn the economy around by basically pumping out more cash, which would make the dollar weaker and help lower the cost of U.S. exported goods and hopefully build jobs here in the United States. Does it mean we would get fewer euros for our dollars when we go to exchange money? Should we exchange our dollars for euros before the value of the dollar plummets? If not all, should we hedge our bets and exchange half of it now and the rest in March? We're just trying to do the smart thing.

CHRISTINA, MAPLE GROVE

A First of all, I'm jealous. I lived in Italy for six months and I loved traveling around the country in the spring. Secondly, you got the economics right. The Federal Reserve's $600 billion quantitative easing program -- the so-called QE2 -- is the electronic equivalent of running the printing press and, therefore, the policy should bring down the value of the dollar in foreign exchange markets. And a lower dollar is one way to support U.S. export growth. The dollar is down a fraction over 4 percent since Aug. 25, and it's almost 14 percent below its recent peak in March 2009.

But should you run out and buy euros? Problem is, the euro is under a lot of pressure, too. The epicenter of trouble at the moment is Ireland. It's an economic and financial basket case with a government budget deficit for 2010 -- including the cost of bailing out its banks -- at 32 percent of gross domestic product. Ireland's embattled government under Prime Minister Brian Cowen is struggling to negotiate the terms of a $100 billion-plus bailout from the European Union and the International Monetary Fund. It is far from clear whether the initiative will work, but there's no question that Ireland's troubles have reignited concerns about the debts of the European periphery, especially Portugal and Greece.

The foreign exchange market is huge, with average daily trading volume estimated at nearly $4 trillion. Trends in the foreign exchange market can depart from the economic fundamentals for long periods of time. Short-term currency forecasting is the equivalent of playing a game of darts at an Irish pub blindfolded. That said, over the past week market sentiment seems to have shifted in the currency markets, at least for now. Confidence in the value of the dollar is on the rise and investors are increasingly downbeat about the euro.

So, what can you do? Your trip isn't very far off. It might make sense to buy some euros in small batches several times between now and April as a hedge. I wouldn't buy so much that you'll kick yourself if the dollar strengthens and just enough so that if the opposite happens you'll have a slight spring in your step. Have a wonderful trip.

Chris Farrell is economics editor for "Marketplace Money." Send questions to cfarrell@mpr.org.

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