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The euro is nearing parity with the dollar: Here’s what it could mean for
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THE EURO IS NEARING PARITY WITH THE DOLLAR: HERE’S WHAT IT COULD MEAN FOR
INVESTORS

Published Thu, May 19 20221:11 AM EDTUpdated Thu, May 19 20226:13 AM EDT
Elliot Smith@ElliotSmithCNBC
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Key Points
 * As of Wednesday afternoon in Europe, the euro was hovering just above $1.05,
   having been in steady decline for almost a year, down from around $1.22 last
   June.
 * Sam Zief, global head of FX strategy at JPMorgan Private Bank, told CNBC on
   Wednesday that the path to parity would require “a downgrade in growth
   expectations for the euro area relative to the U.S., akin to what we got in
   the immediate aftermath of the Ukraine invasion.”

The euro sign sculpture stands outside the former European Central Bank (ECB)
headquarters in Frankfurt, Germany, on Sunday, July 3, 2016.
Krisztian Bocsi | Bloomberg | Getty Images

The euro is nearing parity with the U.S. dollar for the first time in 20 years,
but currency strategists are divided on 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, having
been in steady decline for almost a year, down from around $1.22 last June. The
common currency slid to just above $1.03 earlier this week.



The dollar has been strengthened by risk aversion in markets as concerns about
Russia’s war in Ukraine, surging inflation, supply chain problems, slowing
growth and tightening monetary policy have driven investors toward traditional
“safe haven” assets.

The narrowing between the two currencies has also been driven by divergence in
monetary policy among central banks. The U.S. Federal Reserve earlier this month
raised benchmark borrowing rates by half a percentage point, its second hike of
2022, as it looks to rein in inflation running at a 40-year high.

VIDEO12:3512:35
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Fed Chairman Jerome Powell said on Tuesday that the central bank will not
hesitate to continue raising rates until inflation comes down to a manageable
level and repeated his commitment to bring it closer to the Fed’s 2% target.

The European Central Bank, by contrast to the Fed and the Bank of England, has
yet to raise interest rates despite record high inflation across the euro zone.
However, it has signaled the end of its asset purchase program and policymakers
have struck a more hawkish tone of late.

ECB policymaker Francois Villeroy de Galhau said on Monday that excessive euro
weakness threatens price stability in the bloc, increasing the cost of
dollar-denominated imported goods and commodities and further fueling the price
pressures that have driven euro zone inflation to record highs.




WHAT WOULD IT TAKE TO GET TO PARITY?

Sam Zief, global head of FX strategy at JPMorgan Private Bank, told CNBC on
Wednesday that the path to parity would require “a downgrade in growth
expectations for the euro area relative to the U.S., akin to what we got in the
immediate aftermath of the Ukraine invasion.”

“Is that possible? Sure, but it’s certainly not our base case, and even in that
case, it does seem like euro at parity becomes your worst case scenario,” Zief
said.

Chart

Line chart with 313 data points.
The chart has 1 X axis displaying Time. Range: 2021-05-18 00:00:00 to 2022-05-18
00:00:00.
The chart has 1 Y axis displaying values. Range: 1 to 1.25.

Created with Highcharts 9.0.1Jul ’21Sep ’21Nov ’21Jan ’22Mar ’22May
’2211.051.11.151.21.25cnbc.com
End of interactive chart.



He suggested that the risk-reward over a two to three-year period — with the ECB
likely escaping negative rate territory and fewer fixed income outflows from the
euro area — means the euro looks “incredibly cheap” at present.

“I don’t think there’s many clients that are going to look back in two to three
years and think that buying euro sub-$1.05 was a bad idea,” Zief said.

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Why is the dollar so powerful?
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He noted that the Fed’s aggressive interest rate hiking cycle and quantitative
tightening over the next two years are already priced into 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 ECB that will affect the EURUSD pair.

“It’s also the evolution of the EUR’s core balance of payments flows, and the
prospect of additional negative energy supply shocks, which are also dragging
the currency lower,” he said.

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“We have not seen evidence of a large build-up in EURUSD short positions on the
part of leveraged funds in the data we track, which leads us to believe that the
EUR is weak because of a deterioration in underlying core flows.”

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

“It would not be surprising to see ECB policy inertia continue if the central
bank is faced with the worst possible combination of higher recession risk in
Germany and additional sharp rises in prices (i.e. the dreaded stagnation),”
Gallo said.

“For the Fed’s part in all this, I believe the Fed would become alarmed by a
move to the 0.98-1.02 range in EURUSD, and this extent of USD strength vs the
EUR, and I could see a move to this area in EURUSD causing the Fed to pause or
slow its tightening campaign.”


DOLLAR ‘TOO HIGH’

The dollar index is up around 8% since the start of the year, and in a note
Tuesday, Deutsche Bank said the “safe haven” risk premium priced into the
greenback was now at the “upper end of extremes,” even when accounting for
interest rate differentials.

Deutsche Bank Global Co-Head of FX Research George Saravelos believes a turning
point is close. He argued that we are now at a stage where further deterioration
in financial conditions “undermines Fed tightening expectation” while a great
deal more tightening remains to be priced in for the rest of the world, and
Europe in particular.

“We don’t believe Europe is about to enter a recession and European data – in
contrast to the consensus narrative – continues to outperform the U.S.,”
Saravelos said.

VIDEO4:4504:45
Finland’s Rehn says the ECB should move quickly with a rate hike
Squawk Box Europe


Deutsche Bank’s valuation monitor indicates that the U.S. dollar is now the
“world’s most expensive currency,” while the German lender’s foreign exchange
positioning indicator shows that dollar long positions against emerging market
currencies are at their highest since the peak of the Covid-19 pandemic.

“All of these things give the same message: the dollar is too high,” Saravelos
concluded. “Our forecasts imply EUR/USD will go back up to 1.10 not down to
parity in coming months.”


THE CASE FOR PARITY

While many analysts remain skeptical that parity will be reached, at least
persistently, pockets of the market still believe that the euro will eventually
weaken further.

Interest rate differentials vis-à-vis the U.S. shifted against the euro after
the Fed’s June 2021 meeting, in which policymakers signaled an increasingly
aggressive pace of policy tightening.

Jonas Goltermann, senior markets economist at Capital Economics, said in a note
last week that the ECB’s recent hawkish shift has still not matched the Fed or
been enough to offset the increase in euro-zone inflation expectations since the
turn of 2022.

VIDEO4:5604:56
JPMorgan: Investors can monetize volatility in foreign exchange market
Squawk Box Europe


While Capital Economics expects the Fed’s policy path to be similar to that
priced in by markets, Goltermann expects a less aggressive than discounted path
for the ECB, implying an additional shift in nominal interest rate differentials
against the euro, albeit a much smaller one than that seen last June.

Deteriorating euro zone terms of trade and a global economic slowdown with
further turbulence ahead – with the euro more exposed to financial tightening
due to the vulnerability of its periphery bond markets – further compound this
view.

“The upshot is that – contrary to most other analysts – we forecast the euro to
weaken a bit further against the dollar: we expect the EUR/USD rate to reach
parity later this year, before rebounding toward 1.10 in 2023 as the headwinds
to the euro-zone economy ease and the Fed reaches the end of its tightening
cycle,” Goltermann said.


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