Rate Increase Good News for Euro

06/29/2011 3:23 pm EST

Focus: GLOBAL

Jim Jubak

Founder and Editor, JubakPicks.com

Just so nobody thinks he’s going soft, yesterday the outgoing European Central Bank President, Jean-Claude Trichet, used the bank’s code phrase “strong vigilance mode” in a press conference in Amsterdam.

The language has become the bank’s signal that a rate increase is just down the road. It’s now a virtual certainty that the bank will raise interest rates when it meets in Frankfurt on July 7. (The bank’s benchmark rate is now 1.25%.)

The European Central Bank raised its benchmark rate in April for the first time in three years. But then Trichet disappointed financial markets by not raising rates again at the bank’s next meeting.

The pause was understandable—Greece was back in deep crisis mode, and the last thing the Greek economy needed was higher interest rates pushing down on growth. But financial markets had bid up the euro in a belief that higher rates were just around the corner.

When they weren’t, traders sold, sending the currency staggering against the US dollar.

But Trichet’s signal—and then the actual rate increase on July 7—will reverse that, and push the euro back up against the dollar.

Think about it. If euro-denominated assets pay 1.5% (after the July 7 increase), and US dollar-denominated assets pay 0.25%—with no chance that the Federal Reserve will raise interest rates until the very end of 2011, if then—investors will buy euro assets and sell dollar assets.

All things being equal—which they never are, of course—a weaker dollar will send commodity prices higher. Commodities are priced in dollars...so when the dollar is worth less, sellers of things like oil, copper, and coffee ask for more dollars.

That will feed into what is now shaping up as a decent July bounce (and maybe even a rally). I don’t want to count my chickens before the Greek parliament votes on them, but if the next days and weeks bring an interest-rate increase from Frankfurt and “progress” from Athens, I’d expect to see the current upward bias in stock prices continue for a while.

How long, exactly?

Last year, the June slump was followed by a July to early August rally, and then a replay of the slump in late August. In most years, July is a good month for stocks, partly due to cash flows from retirement funds.

August is the second-worst month for the Dow and S&P 500. In other words, the odds favor a replay of last year’s patterns.

Enjoy this rally while we have it.

Full disclosure: I don’t own shares of any of the companies mentioned in this column in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this column. For a full list of the stocks in the fund as of the end of March, see the fund’s portfolio here.

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