Turbulence Ahead Of EUR/USD Parity
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It has been 20 years since the Euro has been trading at a premium over the US Dollar. Like many correlations in exchange markets, the relationship that started towards the beginning of the European Union kickoff has ended in July 2022. For the first time in two decades, one Euro is worth one US Dollar, creating an unexpected parity. The chart below shows how the EUR/USD exchange rate has been decreasing consistently from the 1.18 level since July 2021.
Before we start burying the Euro, even if the parity level can be broken, the situation is not yet alarming. However, some elements suggest that moving forward, turbulence is expected as these two currencies navigate a war, inflation, and market downturns.
United States vs. Europe Policies
The United States economy is still adjusting to the new bear market environment, but the European Union has been affected in a deeper way since 2020. The U.S. Fed has been fighting inflation for the past few months with multiple interest rate increases. The European Central Bank (ECB) hasn’t done any interest rate policy changes, blaming the COVID recovery as a contributor to this decision. However, the ECB announced its plans to raise interest rates by 25 basis points in July, building faith in the Euro’s ability to recover. Compared to Europe, the U.S. has been fighting the last result from COVID-related quantitative easing packages: Inflation. Another common cause for the currency sinking is the war in Ukraine causing rising risk of recession; Europe is greatly affected as its dependence on Russian resources is stronger than the United States. There is now a 45% chance of recession compared to 30% chance for the U.S.
Repercussions on the Markets
High inflation is already reducing purchasing power for Americans (and Europeans) and a stronger dollar, compared to the Euro, is not great news either. Many European companies have been importing from the United States. Now that the USD is stronger, they may want to rethink their strategy and start producing domestically. European companies that have subsidiaries in the U.S. now have higher costs than anytime before. Continuing that argument, American companies may want to start producing or importing from Europe to take advantage of cheaper products and resources. Prior to today, European travelers to the United States were getting the most out of their high-rated euro, while Americans traveling to Europe were finding life very expensive overseas. If the trajectory continues its course, these relationships will be reversed.
The examples described above will also converge at a certain point. When demand for European products increases and supply is limited, then the price of European products will rise, increasing European company's profits and allowing the Euro to go back to higher levels. However, this cycle can take years before happening.
Opportunities
The EUR/USD parity is good news for Americans wanting to travel abroad but bad news for some U.S. companies like we have been discussing above. For the U.S. investor, this may present some opportunities in the market. More particularly, industries that depend on European tourism such as the International Consolidated Airlines Group (IAG.L), the operator of British Airways among others, or luxury goods vendors such as LVMH Group, present some opportunities for a lower EUR/USD exchange rate.
The 1:1 level is an important psychological threshold for the market. The Euro is considered one of the world’s key currencies and for currency traders, turbulence in near term volatility is expected as billions of Euros in options bets are on the line.
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Disclosure: I wrote this article myself, and it expresses my own opinions. I have no business relationship with any company whose stock is mentioned in this article.
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