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Could Volkswagen’s fraud affect the FX market?

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time is money

time is money

Talking Points:

>What Happened With VW?

>Could This Affect Draghi’s Plans?

>What To Watch For With the Euro and VW?

The auto manufacturer, Volkswagen is facing their biggest crisis in their 78-year-old history. Volkswagen installed software in order to trick the Environmental Protection Agency so that they would not have to spend as much money on their cars to bring them up to regulatory measures and make larger profits.

However, it is important to note that carmakers are a critical part of the European economy that is already on thin ice and therefore it is important to see what this new scandal could potentially do to further derail the European Central Bank’s goals for European competitiveness on a global scale.

So far, the rigging software appears to be making a dent in the already fragile auto-company. Switzerland has banned the sale of some VW diesels and once loyal environmental conscious consumer base, may never trust the automaker again though this is current speculation. At worst, Volkswagen will have billions of dollars in fees globally in addition to losing a loyal customer base and potentially having to buy back cars and sold under false pretenses as well as have already been booked to the company’s profit statements in prior quarters. A lot of this has already been priced in as the first two days after the news broke, the company’s stock, which trades on the Deutsche Boerse AG German Stock Index or DAX saw a decline of nearly 40%, capping its steepest two-day loss since October 2008.

Could This Affect Draghi’s Plans?

Since 2014, as the EUR was strengthening aggressively versus the other G 10 currencies, ECB Pres. Mario Draghi had mentioned the need to bring the euro to a more competitive level in order to boost exports. So knowing that exports are critical to the European economy as a whole, and Germany is arguably the strongest economy within the euro it is important to note that the automotive industry is the largest industry sector in Germany whereas in 2014 the sector had a turnover of nearly 20% of total German industry revenue.

Of course, in our interconnected economy, there is a supply chain so that there are many companies within Germany and surrounding countries that likely also depend on companies like Volkswagen for their sustainability. Therefore, you can see why this scandal could bring a new headache for the European Central Bank as the largest automaker in Germany and largest German company by revenue according to Forbes faces a scandal that it may not bounce back from.

Currently, there are more questions than answers. However the first question will naturally be whether or not other companies have been doing this as well, which could further damage the reputation of German carmakers. Any significant reduction in sales could cause the supply chain to see a drop in demand similar to 2008.

What to Watch For With the Euro and VW?

What makes this scenario unique is that nobody knew to watch for it. Therefore, seeing the spillover effects of the German economy and the reactions of Angela Merkel and Mario Draghi will be telling. We have already heard from ECB members about the weakness of emerging markets like China hurting exports and possibly preempting the need for an extension of the quantitative easing program before the scandal was known.

Since March 13, 2015, EURUSD has been moving sideways after an abrupt drop from 1.3992 in May 2014 to 1.0460 in March. Surprising to many, the current risk off environment due in part to China, commodities, and equity markets is actually seen the euro strengthened on a relative basis whereas many thought the fall would continue. The risk off mood increasing could bring the euro higher yet again which would likely encourage more easing from the ECB.

It may be helpful to keep an eye on the Volkswagen’s stock price as well as their credit default swap rating which is quintupled since before the announcement. If the credit default swap price, which is effectively an insurance product against the default of the company, rises another companies within Germans critical automotive industry, then we may see some more euro strength followed by euro weakness on an announced extension of the ECB’s QE program. 

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