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German quits, euro surges
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March 11, 1999: 4:31 p.m. ET
Dollar, Treasury prices give way after Lafontaine resignation spurs euro rally
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NEW YORK (CNNfn) - The surprise resignation of German Finance Minister Oskar Lafontaine upset world money markets Thursday, giving the euro a firm kick upward that in turn helped Treasury prices drift softly lower.
Lafontaine, a linchpin of Germany's fragile leftist Social Democrat-Green cabinet, resigned his post after only six months. While in office, he had been a dogged advocate of lower interest rates as a motor for European economic growth.
In recent weeks, the euro has remained in the basement of its eleven-week career, drifting from low to low on speculation that Lafontaine and other vocal figures would drive the European Central Bank would have to cut rates, galvanizing the continent's sluggish economies at the expense of its currency.
The absence of Lafontaine now frees the ECB from its most notorious rate gadfly, allowing currency traders to build confidence in the bank's independent judgment.
For its part, the euro showed its gratitude by leaping two full cents against the dollar from its session lows, climbing to $1.1025.
"I guess it is a very significant move," said Hans Redeker, Chase Manhattan economist. "You have to understand that Lafontaine as finance minister was disliked by the Germany corporate sector . . . What we did see in Germany is that the economic situation deteriorated quite sharply from October onwards. If you like, it was to some extent homemade."
The yen also steered into the euro's upward wake, forcing the dollar down to 119.31 yen from its previous close of 119.76. However, at least one economist said that the yen's newfound strength was transitory at best.
"Now, against Japan it's a different story," said James O'Sullivan, J.P. Morgan economist. "A lot of what's happening in Japan reflects this talk about monetization -- generally trying to reflate the economy by increasing money supply. And as long as that's the policy, then that's a recipe for a weaker yen, and that probably continues throughout the year."
Rate cut still likely
While many analysts still forecast a European rate cut ahead, the difference is that now investors will see the action as emerging from the ECB as undisputed monetary authority, and not from a German official.
The markets are definitely looking for the new euro bank to reduce rates," said Bob LaFleur, chief investment strategist at Northern Trust. "This probably increases the chances slightly. That may put a little further pressure on the euro and a little further support for the dollar. But I think any interest rate changes there will be relatively minor."
LaFleur noted that European rates are "already low" and the second half of 1999 already looks stronger than the first, so any ECB cut would simply serve as "further icing on the cake."
Germany's fledgling Social Democrat-dominated government has wobbled dramatically in just the last few days, with Chancellor Gerhard Schöder himself having to deny reports Thursday that he is contemplating resignation. In resigning from his post, Lafontaine also resigned from the Social Democrats, which he formerly chaired.
Treasury market slips
Treasury bonds took a hit from the dollar's retreat, falling in an indifferent news climate once institutional traders started to sell U.S. paper to raise cash for buying into the rallying European bond market.
By 3:00 p.m. ET, the benchmark 30-year Treasury bond was down 3/32 of a point in price at 95-14/32, while the yield edged up to 5.56 percent.
Chase Manhattan's Redeker said European bonds, especially German Bunds, had leapt for joy on the Lafontaine news.
"We have already seen that the euro appreciated after the news came out," he said. "And we see, as well, that the Bund market moved sharply higher and I expect that tomorrow's equity market will follow quite substantially."
Traders said the market had found little lasting direction in the morning's economic reports, while many investors had already retreated to the sidelines ahead of Friday's producer price index, the last major economic release of the week.
Although the market remains confident that the data will show continuing mild inflation, rising oil prices are likely to make any surprises here unpleasant ones.
Bob LaFleur of Northern Trust said it was unlikely that Thursday's Treasury stumble would have much lasting effect.
"Our best opinion is that the bond market will rally," he said. "Having backed off already from the high (yield) of nearly 5.7 percent, we think yields could drift back lower over the next three or four months." 
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