About 7 percent depreciation of the euro against the dollar this year breathes new life into the issue on Wall Street twenty years ago: will this year the currency finally reach parity?

The euro fell about $ 1,035 earlier this month, compared to the $ 1,137 it ended last year. On Friday, it ended at around $ 1,057, which removes it by just over 5% from parity, or equal to the dollar.

The euro and the dollar last reached parity in late 2002, although the single European currency has been on the threshold in the past. In late 2016, the euro went into parity after former President Donald Trump won the US presidential election, and traders expected a series of interest rate hikes by the Federal Reserve. These rates, however, unraveled in 2017 after faster-than-expected growth in Europe.

Some market observers say the possibility of parity is real this time, as traders are battling the Fed’s hawk, the impact on Europe from Russia’s war in Ukraine and China’s economic slowdown. Many economists and investors expect rising energy prices and supply disruptions caused by the war to stifle growth in Europe. Any weakening of demand in China for European goods could also greatly complicate the region.

Meanwhile, the Fed has launched an aggressive campaign to raise interest rates, providing a further boost to the dollar, which this year has become one of the preferred havens for investors. Higher interest rates typically support the dollar, making U.S. assets more attractive to profit-seeking investors. Meanwhile, the European Central Bank is expected to continue to lag behind the Fed in tightening monetary policy.

These factors led to the euro and the dollar fluctuating sharply this year, including on Thursday, when the euro rose 1.2% against the dollar, the biggest jump in more than two months. The euro reversed some of those gains on Friday as it fell 0.2%.

Despite this, the euro has the worst start to the year since 2015, according to Dow Jones Market Data. This has led some analysts and investors to reconsider parity expectations in recent weeks.

“For us, the chances are [the euro and dollar] trade on parity has increased from 30% at the beginning of the war in Ukraine to 75% now, ”said Virage Patel, global macro strategist at Vanda Research. “A small increase in the ECB rate can do very little for an arrest [euro’s] decline ».

The euro and the dollar last reached parity in late 2002.


Photo:

shahzaib akber / Shutterstock

Given the psychological level of the currency pair, the euro-dollar parity also has important implications for the local economy and consumer wallets. For Americans traveling abroad this summer, a weak euro means their dollars could go further.

For European economies, a weak euro makes imports more expensive, which can lead to higher local prices. This could put additional strain on the economy at a time when European countries — and others around the world — are already facing sharp inflation.

“In general, a weaker currency affects the acceleration of inflation,” said Jane Foley, head of currency strategy at Rabobank. But, she noted, “These are not necessarily levels [at which the currencies are trading] complicating everything. It is uncertainty and volatility – the pace at which we are moving – that makes it difficult for politicians to try to assess things like inflation. “

A weak euro could also make euro-denominated assets such as stocks less attractive. The Stoxx Europe 600 valuation index has fallen 12% this year, less than the S&P 500’s fall of 18%.

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Investors’ concerns were evident elsewhere: earlier this month, the gap between the yields of Italian and German benchmark government bonds rose to 2,007 percentage points, the highest level since May 2020, according to Tradeweb. On Friday, the spread rose again above 2 percentage points. The widening gap between Italian and German profitability is commonly seen as a barometer of financial stress in the region.

Not all market observers are convinced that the euro-dollar parity is likely. The currency has not yet fallen below the key technical level for the euro – the intraday level of $ 1,034, to which the euro fell in early 2017.

“There’s some technical psychology in this,” said Paul Siana, head of technical strategy for currency at Bank of America.,

noting that the euro jumped higher after falling to an intraday low of about $ 1.035 last week. However, he noted, “perhaps this time [parity] it actually happens because people are less capable of it. ”

Recent data from the Commodity Futures Trading Commission show that leverage last week held a modest net short position against the euro, but less bearish against the currency than last year.

“When I looked at the position of the euro, the first thing that came to mind was, ‘Oh, we still have to go,'” said Ms. Foley, who has a forecast of $ 1.03 per euro in the coming months.

“I think that if we move to an environment where you have these risks for the eurozone – mainly because of energy security, but also because of the slowdown in China – there is a chance that hard bulls will give up,” she said.

In 2021, the US dollar has risen in value since 2015. This is good for many American consumers, but can also hit US stocks and the economy. Photo illustration: Sebastian Vega / WSJ

Write to Caitlin McCabe at caitlin.mccabe@wsj.com

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