A financial trader monitors data while a TV shows euro banknotes on the Frankfurt Stock Exchange in Germany.
Martin Leissl | Bloomberg | Getty pictures
The euro fell below $ 1.02 this week, continuing its decline to new 20-year lows and potential parity with the US dollar.
The euro traded as low as $ 1[ads1].0165 on Wednesday afternoon in Europe, before recovering slightly above the $ 1.02 mark on Thursday morning.
The single currency in the eurozone has been in constant decline as fears of a recession there increase due to growing uncertainty about the bloc’s energy supply, with Russia threatening to further reduce gas supplies to Germany and the wider continent.
The prospect of an economic downturn also casts doubt on whether the European Central Bank will be able to tighten monetary policy sufficiently to curb record high inflation.
Deutsche Bank pointed out in a note on Wednesday that the stress points extend beyond the German natural gas shortage to the broader European energy market, as stated by France’s EDF, which announced further power cuts on Wednesday morning.
Deutsche Global Head of FX Research, George Saravelos, suggested that “safe-haven” movements against the US dollar could become “even more extreme” as the US enters a technical recession, prompting downward pressure on EURUSD trading.
“We conclude that a move down to 0.95-0.97 in EUR / USD will match all-time extremes in terms of exchange rates and USD risk premium since the end of Bretton Woods,” Saravelos said.
“If both Europe and the US find themselves slipping into a (deeper) recession in the third quarter while the Fed continues to raise interest rates, these levels may well be reached.”
An important catalyst that could reverse the strengthening of the US dollar, he suggested, is a signal that the Fed is entering a prolonged pause in the monetary tightening cycle, facilitating the release of some of the risk premiums baked into the dollar.
The DXY US dollar index is up more than 11% so far this year, last trading just below the 107 mark.
Meanwhile, a “clear peak” in European energy tensions via an end to hostilities in Ukraine could offer a path higher for the euro.
“Continued (partial) supply of Russian gas through the summer will in our view not be enough, as the risk of a shutdown will persist until the winter,” Saravelos added.
The darker outlook for the European economy comes as the ECB has announced its intention to raise interest rates for the first time since 2011, with eurozone inflation at a record 8.6%.
Central banks around the world face a dilemma when they try to curb inflation without deepening economic downturns, which the data suggest are drawing ever closer.
The Fed is already well out of the blocks of tightening, after raising the reference rate by 75 basis points in June, while significantly cutting the growth outlook for 2022.
Minutes from the last meeting of the Federal Open Market Committee showed that politicians are worried that the central bank will lose credibility if inflation worsens.
In a research note on Tuesday, capital economics market economist Franziska Palmas said that investors across asset classes discounted a rather unfavorable economic outcome in the eurozone.
“Although we believe it will require a significant further deterioration of the outlook for the eurozone economy for the sub-result of the euro and the eurozone’s assets to continue, we still expect them to continue to struggle,” she said.
“Firstly, we believe that gas supplies in the eurozone will remain tight and gas prices high. This is part of the reason why we expect the eurozone economy to flirt with recession this year, even if we only assume a downturn, instead of stopping Russian gas supplies. “
Palmas added that the backdrop of aggressive rate hikes by central banks and disappointing global economic growth will keep downward pressure on risky assets and trigger further investor flight against the traditional “safe haven” of the US dollar.
“The conclusion is that although we do not expect assets in the eurozone to continue to perform worse than their DM counterparts, we expect their absolute performance to remain poor this year and next,” she said.
On Monday, Germany registered its first trade deficit in goods since 1991, when rising energy prices sent import costs skyrocketing for Europe’s largest economy, while global trade disruptions also stifled exports.
The figures were among a number of data releases in recent days that have highlighted the increasingly challenging economic conditions for the eurozone. The July Sentix Economic Index on Monday showed that investor morale across the eurozone with 19 countries has plummeted to its lowest level since May 2020, which it said pointed to an “inevitable” recession.
“Given the nature of Germany’s commodity – price exports, it is still difficult to imagine that the trade balance could improve significantly from here over the next few months given the expected downturn in the eurozone economy,” said Saxo Bank’s currency strategists. a note last week.
“Meanwhile, high energy prices will continue to take a toll on the trade balance as well, possibly dampening sentiment on the EUR. The EURUSD is likely to find it difficult to go above 1.0500 sustainably, and the focus is therefore on 1.0350 support.”