What does that mean for investors as the pair approaches parity?

A statue of the Euro stands in front of the former European Central Bank headquarters in Frankfurt, Germany, on Sunday, July 3, 2016.

Christian Boxey | Bloomberg | Getty Images

The euro approaching parity with U.S. dollar For the first time in 20 years, currency strategists are divided over whether it will get there, and what it will mean for investors and the economy.

As of Thursday morning in Europe, the euro was hovering around $1.05, after having been in a steady decline for nearly a year, down from around $1.22 last June. The common currency fell to just over $1.03 earlier this week.

The dollar’s strength was boosted by risk aversion in the markets as concerns about the Russian war in Ukraine, rising inflation, supply chain problems, slowing growth and tighter monetary policy pushed investors towards traditional “safe haven” assets.

The tightening between the two currencies was also driven by divergence in monetary policy between central banks. The US Federal Reserve in advance this month Raising benchmark borrowing rates by half a percentage pointIt is the second increase in 2022, as it looks to rein in inflation that has reached its highest levels in 40 years.

Federal Reserve Chairman Jerome Powell said on Tuesday That the central bank would not hesitate to continue raising interest rates until inflation fell to a manageable level and reiterated its commitment to bring it closer to the Fed’s 2% target.

In contrast to the Federal Reserve and the Bank of England, the European Central Bank has not raised interest rates despite record inflation across the eurozone. However, it did signal the end of the asset buying program, and policy makers have taken a more hawkish tone recently.

European Central Bank policy maker Francois Villeroy de Gallo said on Monday that the excessive weakness of the euro is threatening price stability in the bloc, increasing the cost of imported goods and dollars denominated and adding to price pressures that have pushed inflation in the euro zone to record levels.

What does it take to reach parity?

Sam Ziv, global head of foreign exchange strategy at JPMorgan private bank, told CNBC on Wednesday that the path to parity would require “a lowering of the eurozone’s growth outlook for the United States, similar to what we got in the aftermath of World War II.” Ukraine”.

Ziv said, “Is that possible?

He suggested that the risk-reward over a period of two to three years – with the ECB likely to escape a negative rate zone and reduce fixed income outflows from the eurozone – means the euro looks “incredibly cheap” at the moment.

“I don’t think there are many clients who will look back in two to three years and think that buying less than $1.05 of the euro was a bad idea,” Ziff said.

He noted that the cycle of aggressive Fed rate hikes and quantitative tightening over the next two years is already priced in the dollar, a view echoed by Stephen Gallo, European head of FX strategy at BMO Capital Markets.

Gallo also told CNBC via email that it’s not just the prospect of material policy divergence between the Fed and the European Central Bank that will affect the EURUSD.

“It is also the evolution of the basic balance of payments flows to the euro, and the possibility of additional negative shocks to the energy supply, which also lead to a pullback of the currency,” he said.

“We did not see evidence of a significant build-up of short EURUSD on the side of leveraged funds in the data we track, which leads us to believe that the EUR is weak due to deteriorating underlying fundamental flows.”

Gallo suggested that moving toward parity between the euro and the dollar, would require “political deadlock” from the European Central Bank over the summer, in the form of prices remaining unchanged, and a full German ban on imports of Russian fossil fuels, which would lead to energy rationing. .

“It would not be surprising to see the ECB policy stalemate persisting if the central bank faces the worst possible combination of rising recession risks in Germany and additional sharp price hikes (ie a dreaded recession),” Gallo said.

“As for the Fed’s role in all of this, I think the Fed will be concerned about going into the 0.98-1.02 band in EURUSD, that range of USD strength against the EUR, and I could see a move into that area in EURUSD The US is causing the Fed to stop or slow down its tightening campaign.”

The dollar is ‘too high’

The dollar index is up about 8% since the start of the year, and in a note Tuesday, German Bank He said the “safe haven” risk premium priced into the dollar is now at “maximum ends,” even when accounting for interest rate differentials.

George Saravelos, co-head of forex research at Deutsche Bank Global, believes the tipping point is approaching. He argued that we are now at a point where further deterioration in financial conditions is “undermining the Fed’s tightening expectations” while more tightening remains to be priced in in the rest of the world, and Europe in particular.

“We do not believe that Europe is about to enter a recession, and that European data – contrary to the agreed narrative – continues to outperform the US,” Saravelos said.

Deutsche Bank’s valuation watch indicates that the US dollar is now “the most expensive currency in the world”, while the German lender’s foreign exchange position index shows that long dollar positions against emerging market currencies are at their highest levels since the height of the COVID-19 pandemic.

Saravelos concluded, “All of these things carry the same message: the dollar is too high.” “Our forecast is that the EUR/USD will return up to 1.10 and not down to par in the coming months.”

equivalence issue

While many analysts remain skeptical about the possibility of reaching parity, at least insistently, some pockets in the market still believe that the Euro will weaken further in the end.

Interest rate differentials shifted against the US against the euro after the Federal Reserve’s June 2021 meeting, as policymakers signaled an increasingly strong pace of policy tightening.

Jonas Goltermann, chief markets economist at Capital Economics, said in a note last week that the ECB’s recent hawkish turnaround still did not match the Federal Reserve or was enough to offset the increase in eurozone inflation expectations since early 2022.

While Capital Economics expects the Fed’s policy path to be similar to the one that markets are pricing in, Gultermann expects a less aggressive path than the ECB’s discount path, implying an additional shift in nominal interest rate differentials against the euro, albeit much lower than that. It was seen last June.

Deteriorating terms of trade in the eurozone and a global economic slowdown with more turmoil ahead – with the euro exposed to more financial tightening due to weak bond markets in the periphery – further complicate this view.

The upshot is that – unlike most other analysts – we expect the euro to weaken a bit more against the dollar: we expect the EUR/USD to reach parity later this year, before rebounding towards 1.10 in 2023 as economic headwinds The eurozone is falling and the Fed is reaching the end of the tightening cycle.”

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