What does this mean for investors as the pair is close to parity?

The Euro sign sculpture stands outside the former European Central Bank (ECB) headquarters in Frankfurt, Germany, on Sunday, July 3, 2016.

Christian Boxy | Bloomberg | Getty Images

The euro is close to parity with the US dollar for the first time in 20 years, but monetary strategists are divided over whether it will get there and what it means for investors and the economy.

In Europe, as of Thursday morning, the euro was hovering around $ 1.05, down from about 22 1.22 in June last year, in a nearly year-long steady decline. The common currency has slipped above $ 1.03 earlier this week.

The dollar strengthened on market risk aversion as concerns over Russia’s war in Ukraine, rising inflation, supply chain problems, slowing growth and tightening monetary policy pushed investors toward traditional “safe haven” assets.

The narrowness between the two currencies has also been driven by differences in monetary policy between central banks. The US Federal Reserve raised the benchmark lending rate by half a percentage point earlier this month, its second increase in 2022, as it looks to pull the reins of ongoing inflation to a 40-year high.

Fed Chairman Jerome Powell said on Tuesday that the central bank would not hesitate to continue raising rates until inflation reached a manageable level and would reiterate its commitment to bring the Fed closer to its 2% target.

Unlike the European Central Bank, the Fed and the Bank of England, the eurozone failed to raise interest rates despite record high inflation. However, it did signal the end of its asset purchase program, and policymakers have been quick to lash out.

ECB policymaker Francois Villarre de Galhous said on Monday that excessive euro weakness has threatened price stability in the bloc, pushed up the price of dollar-denominated imported goods and commodities and added to price pressures that have pushed eurozone inflation to record highs.

What does it take to get equality?

Sam Jeff, global head of JPMorgan Private Bank’s FX strategy, told CNBC on Wednesday that the path to equality would require a “downgrade of growth expectations for the euro area relative to the United States, which we received along with the Ukraine invasion.”

“Is that possible? Of course, this is certainly not our base case, and even in that case, it seems the euro at parity has become your worst case scenario,” Jeff said.

He suggested that the risk-rewards over a two- to three-year period – with the ECB likely to move out of the negative rate zone and with less fixed income outflows from the euro area – meant the euro was currently looking “incredibly cheap”.

“I don’t think there are a lot of clients who would look back in two to three years and think buying a Euro sub- 1.05 was a bad idea,” Jeff said.

He noted that the Fed’s aggressive interest rate hike cycle and quantitative tightening over the next two years have already set the price in dollars, a view echoed by Stephen Gallo, European head of FX strategy at BMO Capital Markets.

Gallo also told CNBC via email that it was not just the possibility of a monetary policy difference between the Fed and the ECB that would affect the EURUSD pair.

“The main balance of the EUR is the evolution of the flow of payments and the possibility of a surge in the supply of additional negative energy, which is dragging the currency down,” he said.

“We do not see evidence of a large build-up in the EURUSD short position on the part of the leveraged funds in the data we track, which makes us believe that the EUR is weak due to the underlying mainstream downtrend.”

A move towards parity between the euro and the dollar, Gallo suggested, would require ECB “policy inertia” in the summer, in the form of rates remaining unchanged, and a complete German embargo on Russian fossil fuel imports, which would lead to energy rationing. .

“If the central bank faces the worst possible combination of high recession risk in Germany and the sharp sharp rise in prices (i.e. terrible stagnation), it would not be a surprise to see ECB policy inertia continue,” Gallo said.

“For the Fed’s part in all of this, I believe the Fed will be concerned about the EURUSD moving in the 0.98-1.02 range and the USD vs. USD strength level and I see a move in this area in the EURUSD. The Fed will stop or slow its tough campaign.” . “

Dollar ‘too much’

The dollar index has risen nearly 8% since the beginning of the year, and in a note on Tuesday, Deutsche Bank said the price of greenback “safe haven” risk premium is now “at the top end,” even when accounting for interest rate differences.

Deutsche Bank Global Co-Head of FX Research George Saravellos believes a turning point is near. He argues that we are now at a stage where further deterioration of the financial situation “threatens the expectations of the Fed’s austerity” where more austerity pricing remains for the rest of the world and especially Europe.

“We do not believe that Europe is about to enter a recession and that European data – contrary to consensus – is overtaking the United States,” said Saravelos.

Deutsche Bank’s Evaluation Monitor indicates that the US dollar is now “the most expensive currency in the world”, with the German lender’s foreign exchange position indicating that the dollar’s long position against emerging market currencies is higher than the peak of the Covid-19 epidemic.

“All of these things send the same message: the dollar is too much,” Saravellos concluded. “Our forecast indicates that EUR / USD will return to 1.10 in the coming months without falling to parity.”

The case for equality

Although many analysts doubt that parity will be reached, at least consistently, market pockets still believe that the euro will eventually weaken further.

Since the Fed’s June 2021 meeting, interest rates have shifted to the euro compared to the US, with policymakers signaling an increasingly aggressive pace of policy tightening.

Jonas Golterman, senior market economist at Capital Economics, said in a note last week that the ECB’s recent hockey shift has not yet matched the Fed’s or is not enough to offset rising Euro-zone inflation expectations from the 2022 turn.

Although Capital Economics expects the Fed’s policy path to be similar to market prices, Golterman expects a less aggressive approach to the ECB than a discount path, indicating additional changes in the nominal interest rate differential against the euro, albeit much smaller. Seen last June.

The deteriorating euro zone conditions of trade and a global economic downturn with further turmoil ahead – the scope of the euro exposure due to the weakness of the bond market – further complicate this view.

“Unlike other analysts – we forecast the euro to weaken further against the dollar: we expect the euro / USD rate to reach parity by the end of this year, the eurozone economy eases before it returns to 1.10 in 2023 and the Fed reaches the end of its tough cycle. “Goltermann said.

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