A sculpture of the euro symbol stands outside the former European Central Bank (ECB) headquarters in Frankfurt, Germany, on Sunday, July 3, 2016.
Christian Bossi | Bloomberg | Getty Images
In Europe as of Thursday morning, the euro was hovering around $1.05, having fallen steadily for nearly a year from around $1.22 last June. The common currency fell to just above $1.03 earlier this week.
The U.S. dollar strengthened on risk-off sentiment as concerns over Russia’s war in Ukraine, soaring inflation, supply chain issues, slowing growth and tightening monetary policy prompted investors to turn to traditional “safe haven” assets.
The narrowing between the two currencies was also driven by differences in monetary policy among central banks.this Fed Earlier this month Raise the benchmark lending rate by half a percentage pointthe second rate hike in 2022, as it looks to rein in inflation to the highest level in 40 years.
Federal Reserve Chairman Jerome Powell said on Tuesday The Fed will not hesitate to keep raising rates until inflation falls to a manageable level, and reiterated his commitment to bring it closer to the Fed’s 2% target.
Compared to the Federal Reserve and the Bank of England, the European Central Bank has yet to raise interest rates, despite record inflation across the euro zone. However, it has signaled the end of its asset-buying program, and policymakers have adopted a more hawkish tone of late.
ECB policymaker François Villeroy de Gallo said on Monday that excessive weakness in the euro threatens price stability in the euro zone, increases the cost of dollar-denominated imports and commodities and further exacerbates the Eurozone inflation pushed price pressures to record highs.
What does it take to reach parity?
Sam Zief, head of global FX strategy at JPMorgan Private Bank, told CNBC on Wednesday that the path to parity would require “downgrading growth forecasts for the euro area relative to the U.S., similar to what we got immediately after the crisis. The Ukrainian invasion.”
“Is it possible? Of course, but it’s certainly not our base case, and even in that case, euro parity does seem to be the worst case scenario,” Ziff said.
He said the risk-reward of two to three years – the possibility of the ECB moving out of negative interest rate territory and the reduction of fixed income outflows from the euro zone – meant the euro looked “very cheap” at the moment.
“I don’t think many customers will look back in two to three years and think buying the euro below $1.05 is a bad idea,” Ziff said.
He noted that the Fed’s aggressive rate hike cycle and quantitative tightening over the next two years are already priced into the dollar, a sentiment echoed by Stephen Gallo, head of European FX strategy at BMO Capital Markets.
Gallo also told CNBC via email that it’s not just the prospect of a major policy disagreement between the Federal Reserve and the European Central Bank that affects the euro-dollar exchange rate.
“It’s also the evolution of the euro’s core balance of payments flows, and the prospect of additional negative energy supply shocks, which also dragged the euro lower,” he said.
“In the data we track, we do not see evidence of a substantial increase in short positions in EUR/USD by leveraged funds, which leads us to believe the weakness in the euro is due to a deterioration in underlying core flows.”
Gallo suggested that parity between the euro and the dollar would require the ECB to adopt “policy inertia” over the summer, namely keeping interest rates on hold and Germany’s blanket embargo on Russian fossil fuel imports, which would lead to energy rationing.
“If the ECB faces a worst-case combination of rising risk of a recession in Germany and a further sharp rise in prices (i.e. a horrific stagnation), it should come as no surprise that the ECB’s policy inertia continues,” Gallo said.
“As far as the Fed is concerned, I believe the Fed will be shocked by the 0.98-1.02 range in EUR/USD and this level of strength in USD/EUR, and I might see EUR/USD moving into that zone causing the Fed to pause or slow down its austerity policies.”
Dollar ‘too high’
The U.S. dollar index is up about 8 percent since the start of the year, and in a report on Tuesday, Deutsche Bank Even taking into account interest rate differentials, the “safe haven” risk premium factored into the U.S. dollar is now at the “extreme upper end,” he said.
George Saravelos, co-head of global FX research at Deutsche Bank, believes a turning point is coming. He believes that we are now in a phase where financial conditions are further deteriorating “undercutting Fed tightening expectations”, while the rest of the world, especially Europe, still has a lot of tightening to digest.
“We don’t think Europe is about to enter a recession, and European data — contrary to popular belief — continue to outperform the U.S.,” Saravelos said.
Deutsche Bank’s valuation monitor shows the dollar is now “the world’s most expensive currency”, while the German bank’s FX position indicator shows long dollar positions against emerging market currencies at their highest level since the peak of the Covid-19 pandemic .
“All of these send the same message: the dollar is too high,” Saravelos concluded. “Our forecasts imply that EUR/USD will recover to 1.10 in the coming months rather than fall to parity.”
While many analysts remain skeptical, at least persistently, that parity will be achieved, some in the market still believe the euro will eventually weaken further.
The rate differential with the U.S. changed against the euro after the Fed’s June 2021 meeting, where policymakers signaled an increasingly aggressive pace of policy tightening.
Jonas Goltermann, senior market economist at Capital Economics, said in a report last week that the ECB’s recent hawkish turn is still not on par with the Fed, nor is it enough to offset the decline since early 2022. Eurozone inflation expectations rose.
While Capital Economics expects the Fed’s policy path to be similar to that priced in by the market, Goltermann expects the ECB’s path to be less aggressive than the discounted path, implying further changes in nominal spreads to the euro, albeit much smaller than last June. arrived.
Deteriorating terms of trade in the euro zone and a slowing global economy and further volatility ahead – the euro is more vulnerable to financial tightening due to the vulnerability of its peripheral bond markets – further add to this view.
“The upshot is that – contrary to most other analysts – we are forecasting further EUR/USD weakness: we expect EUR/USD to reach parity later this year before rebounding to 1.10 in 2023. slow, the Fed ends its tightening cycle,” Goldman said.