UPDATE: In my enthusiasm and haste to plug Lars Chritensen’s post on the possible end of the Eurozone crisis, I got carried away and conflated two separate effects. The dollar’s appreciation against from July to September was associated with a steep drop in inflation expectations, the TIPS spread fallling from about 2.4% in July to about 1.7% on 10-year Treasuries. The dollar rose against the euro from July to September from the exchange rate moving from the $1.42 to $1.45 range in early July to the $1.35 to $1.38 range in September. From September to December, inflation expectations rose modestly, the TIPS spread on 10-year Treasuries recovering to about 1.9%. It has only been since December that the dollar has been appreciating against the euro even as inflation expectations have risen to over 2% as reflected by the TIPS spread on 10-year Treasuries. The actual data are thus more consistent with Lars’s take on the Eurozone crisis than suggested by my original comment .Sorry for that slip-up on my part.
Check out this fascinating post by Lars Christensen on how the Eurozone Crisis (not to be confused with the Greek Debt Crisis) came to an end last July. The key to understanding what happened is that on July 1 the dollar/euro exchange rate was $1.4508/euro. Yesterday it was about $1.32/euro. The appreciation of the dollar would have been a disaster for the US and the rest of the world, except for the fact that inflation expectations in the US have increased, not decreased, since July (even as measured inflation — both headline and core — has fallen). Ever since 2008, US inflation expectations and the dollar/euro exchange rate have been positively correlated (i.e., increased inflation expectations in the US have been associated with a falling value of the dollar relative to the euro). Since July US inflation expectations have increased while the dollar has appreciated against the euro.
HT: Lars Christensen and Marcus Nunes