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Saturday, November 19, 2016

The Euro and the US Dollar Flirt with Parity

Euro, Dollar Flirt With Parity

Trump outlook and Fed’s likely move are strengthening dollar, and ECB may not help stop euro’s fall

The euro has been shrinking against the backdrop of the dollar. Photo: Reuters

(Image: A stack of Euro's on top of 100 US Dollar bills spread on a surface)

Nov. 19, 2016 9:20 a.m. ET | Source

A 10-day losing streak for the euro against the U.S. dollar is rekindling an old debate:

Will the single currency reach parity with the dollar?

In the last two weeks, the euro has fallen 4% against the dollar, hitting $1.06, a level last seen 12 months ago.

The sharp shift in expectations for U.S. interest rates and economic growth since the presidential election has refueled the euro’s relative fall against the greenback. If the Federal Reserve increases rates, expectations are the dollar would rise further by drawing money to the U.S. looking for higher returns.

The European Central Bank, meanwhile, is showing few signs of a major shift in a monetary policy that has pushed rates into negative territory and includes a massive bond-buying program.

The euro also has to contend with a gauntlet of coming eurozone votes that could increase power for the sort of populist parties that, many investors believe, embrace policies that could stymie growth.

Following Donald Trump’s victory, Citigroup said it had shifted its euro-dollar forecast “180 degrees.” The bank now predicts the euro will tumble to just 98 cents in the next six to 12 months. This week others have joined the bank in predicting parity. The euro Friday closed at $1.058 in European trading.

The divergence of U.S. monetary and fiscal policy with the rest of the world “should be very beneficial to the dollar,” said Adnan Akant, head of currencies at asset management firm Fischer Francis Trees & Watts.

Mr. Akant now believes that parity could be reached fairly soon.

“Well, that’s only 7% to 8% away; yes, I would think so,” he said.

The euro’s decline could be good for the European economy. A weaker exchange rate will make the eurozone’s exports more competitive and should encourage inflation, which has been persistently below the ECB’s target near 2%. But such trends are not all good news for consumers, who will see a rise in the cost of dollar-denominated imports like oil.

Launched in 1999, the single currency spent much of its early years below parity, falling to as low as 83 cents in 2000, when there was a strong U.S. economy and a weak one in Europe.

But the currency has traded above $1 since late 2002, climbing to a high of $1.60 as the U.S. struggled with the financial crisis in 2008.

Analysts were last predicting parity in early 2015, when the euro was dragged down by the ECB’s introduction of quantitative easing, a bond-buying program designed to push down interest rates.

That March, the euro fell to as low as $1.046. But U.S. interest-rate rises didn’t occur as fast as economists were predicting, puncturing the trade
Monetary policy divergence is once again driving the euro lower against the dollar.

Goldman Sachs expects one interest-rate increase soon from the Federal Reserve, followed by another three in 2017, and believes the ECB will extend its QE program to the end of 2017.

But the current fall is also different from 2015’s big decline. Back then, the euro dropped against the currencies of almost all its major trading partners. This time, the euro is actually up 1.8% this year against a trade-weighted basket.

Not all strategists believe parity is destined. There are two actors in this trade, the euro and the dollar.

“A lot of good news has already been priced in for the U.S., possibly too much,” said Geoffrey Yu, head of the U.K. investment office at UBS Wealth Management, who also bet against parity in early 2015.

“If you just look at how the eurozone has performed in terms of data, things look better than they did the last time people were gunning for parity,” he said.

The eurozone economy has grown slowly but consistently for each of the last nine quarters, expanding by between 0.3% and 0.8% of GDP every three months.

Alongside interest-rate expectations, political risk is weighing on the currency.

“Both blades of the scissor are moving against the euro right now,” said Marc Chandler, a strategist at Brown Brothers Harriman in New York. “My view is that the currency goes to record lows.”

Europe has already witnessed one political earthquake this year, when the British surprised investors by voting to leave the European Union. Now, the eurozone’s political diary is full of potential market shocks.

Early next month, a constitutional referendum in Italy could sink the government of Prime Minister Matteo Renzi. The resignation of Mr. Renzi, one of Europe’s most reform-minded leaders, could freeze Italy’s economic overhaul and erase the meager growth the country has generated.

Also lining up are key elections in France, Germany and the Netherlands, all of which have seen populist right-wing parties gain support.

Investors “were surprised on Brexit, they were surprised on the U.S. election,” said Mark McCormick, head of North American foreign exchange strategy at TD Securities. “This time, they will want to be more cautious when it comes to Europe.”



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