A financial trader monitors data as a television shows Euro banknotes at the Frankfurt Stock Exchange in Germany.
Martin Leiss | Bloomberg | Getty Images
The euro fell below $1.02 this week, continuing its slide to fresh 20-year lows and potential parity with the US dollar.
The euro was trading as low as $1.0165 on Wednesday afternoon in Europe, before recovering slightly to sit just above the $1.02 mark on Thursday morning.
The common eurozone currency has been on a steady decline as fears of a recession escalate due to growing uncertainty over the bloc’s energy supply, with Russia threatening to further cut gas supplies from Germany and the continent at large.
The prospect of an economic slowdown also casts doubt on the ability of the European Central Bank to tighten its monetary policy enough to contain record inflation.
Deutsche Bank pointed out in a note on Wednesday that the pressure points extend beyond the shortage of German natural gas to the wider European energy market, as evidenced by EDF’s announcement of further gas cuts. electricity Wednesday morning.
George Saravelos, global head of FX research at Deutsche, suggested that “safe haven” moves into the US dollar could become “even more extreme” as the US enters a technical recession, adding pressure to the decline on the EURUSD trade.
“We conclude that a decline to 0.95-0.97 in EUR/USD would be consistent with historical extremes seen in exchange rates and the USD risk premium since the end of Bretton Woods,” Saravelos said.
“If Europe and the US find themselves sliding into (deeper) recession in the third quarter as the Fed continues to hike rates, those levels could well be reached.”
A key catalyst that could reverse the strengthening U.S. dollar, he suggested, is a signal that the Fed is entering an extended pause in its monetary tightening cycle, facilitating the release of some of the embedded risk premium. to the greenback.
The DXY U.S. Dollar Index is up more than 11% year-to-date, last trading just below the 107 mark.
Meanwhile, a “clear spike” in European energy tensions via the end of hostilities in Ukraine could offer a higher path for the euro.
“The (partial) continuation of the Russian gas supply throughout the summer would not be sufficient in our opinion, as the risks of a stoppage would persist until the winter,” Saravelos added.
The darkening outlook for the European economy comes as the ECB announced its intention to raise interest rates for the first time since 2011, with eurozone inflation hitting a record high of 8.6%.
Central banks around the world face a dilemma as they try to contain inflation without deepening economic downturns, which the data shows are looming ever closer.
The Fed is already well out of the blocks on tightening, having raised its benchmark rate by 75 basis points in June while significantly cutting its growth outlook for 2022.
Minutes from the last meeting of the Federal Open Market Committee showed that policymakers feared the central bank would lose credibility if inflation were to deteriorate.
In a research note on Tuesday, financial markets economist Franziska Palmas said investors across all asset classes were pricing in a rather unfavorable economic outcome in the euro zone.
“While we believe it would take a further significant deterioration in the outlook for the eurozone economy for the underperformance of the euro and eurozone assets to continue, we still expect ‘they keep struggling,’ she said.
“On the one hand, we believe gas supplies in the Eurozone will remain tight and gas prices will remain high. This is partly why we expect the eurozone economy to euro is flirting with recession this year, although we only assume a slowdown, rather than a halt in Russian gas supplies.”
Palmas added that the backdrop of aggressive interest rate hikes by central banks and disappointing global economic growth will keep downside pressure on risky assets and trigger another flight of investors to the traditional “safe-haven” US dollar.
“The bottom line is that while we don’t expect Eurozone assets to continue to underperform their emerging market peers, we do expect their absolute performance to remain poor this year and next,” she said.
Germany recorded its first goods trade deficit since 1991 on Monday, as rising energy prices sent import costs skyrocketing for Europe’s biggest economy, while disruption in global trade also stifled exports.
These figures are part of a flurry of data releases in recent days that have highlighted the increasingly difficult economic conditions for the euro zone. The Sentix economic index for July showed on Monday that investor sentiment in the 19 eurozone countries had plunged to its lowest level since May 2020, which it said pointed to an “inevitable” recession.
“Given the nature of German exports which are sensitive to commodity prices, it remains difficult to imagine that the trade balance could improve significantly over the next few months given the expected slowdown in the economy. ‘eurozone economy,’ Saxo Bank’s currency strategists said in a note last week.
“Meanwhile, high energy prices will also continue to weigh on the trade balance, and possibly dampen sentiment in the EUR. EURUSD will likely struggle to break above 1.0500 on a sustainable basis, and the focus is therefore on the support of 1.0350.”