Euro reaches parity with US dollar for first time in 20 years

Look at this: $1 = $1.

With a war on the euro-zone border, an uncertain energy supply from Russia and a growing risk of a recession, pressures on the euro eventually became so strong that this Wednesday it fell to parity with the US dollar – a one-to-one exchange rate. .

It’s an unseen sight since December 2002, in the early years of the mint’s existence. The aesthetically pleasing round number has become a focal point for investors.

In currency markets, “1.00 is probably the greatest psychological level there is,” analysts at Dutch bank ING said in a note to customers.

Even more remarkable than breaking this level is how quickly the euro has fallen against the dollar. The currency, shared by 19 European countries, has fallen more than 11 percent this year as the strength of the dollar is almost unparalleled.

The euro’s sharp decline has come as the dollar, one of the safest places to park money for generations, has strengthened against nearly every major currency in the world.

Currencies move like stocks, bonds or other assets – investors can buy them instantly when they think they will rise in value, and sell them when they think they will fall. They also reflect the global demand for a country’s assets in general, because buying US Treasuries or Apple stock requires first obtaining dollars, and much global dollar trading takes place. So, as often happens in times of economic hardship, people looking for a safe place to keep their money have bought more dollars at the expense of other currencies like the euro.

The euro was introduced in 1999 after decades of discussion and planning, with the aim of bringing unity, prosperity and stability to the continent. After two major wars in the first half of the 20th century, the argument for the euro and the wider European project was that common institutions would reduce the risk of war and crisis and provide diplomatic arenas for conflict resolution. The euro was a critical symbol of this unity.

But like all currencies, the euro is only as strong as people’s belief in it. That was seriously tested about a decade ago when investors fled the debts of heavily indebted countries and bailouts sparked squabbles over fiscal policy. The crisis threatened the future of the currency, but confidence has largely recovered. The eurozone, which started with 11 countries, will welcome its 20th member next year.

In recent months, however, many factors have increased against the euro and in favor of the US dollar, which has once again established itself as a haven during the economic upheaval.

Global supply chains have been disrupted by the pandemic and the war in Ukraine. Since the Russian invasion in February, the prices of essential commodities, including oil, natural gas, wheat and fertilizers, have skyrocketed, pushing food and energy prices up around the world. This has led to the highest inflation rates in decades.

Now central bankers in the United States and Europe have pledged to cut inflation through higher interest rates, even as the global economic outlook deteriorates. The risk of a recession has been exacerbated by restrictions on Chinese production due to Covid-19 rules, while attempts to cut Europe off from Russian energy are proving difficult to accomplish. These trends have strengthened the dollar while doing little to help the euro.

“The outlook remains very favorable for the dollar,” said Ebrahim Rahbari, Citi’s head of currency analysis.

The fall of the euro has heightened concerns that the eurozone could be plunged into recession.

Last week, uncertainty over the future of Europe’s energy supply and growing concerns that Russia would permanently shut down a critical natural gas pipeline to Germany sent the euro to its lowest level in 20 years.

But parity bets started piling up months ago. Jordan Rochester, a strategist at the Japanese bank Nomura, has been betting since April that the euro would reach parity with the dollar. Similar predictions followed, including at JPMorgan Chase and HSBC.

Then came a short breather in the slide of the euro. For example, in July the President of the European Central Bank, Christine Lagarde, set out a clear plan to raise interest rates for the first time in more than a decade, signaling that the eight-year era of negative interest rates would be over by early July. fall. Since then, policymakers have stepped up their commitment, saying that when rates rise again in September, the jump will likely be even greater than in July.

In the end, it was not enough to reverse the exchange rate of the currency. “It’s hard to say much positive about the euro,” HSBC analysts wrote in a note to customers in early July. “The economic news is very challenging.”

At about the same time, Mr. Rochester of Nomura said he expected the euro to reach parity with the dollar by the end of August. In the end it went much faster.

“It’s very human psychology,” Mr. Rochester said. There’s no market-based reason why parity matters — “it’s just a round number,” he added. But it could be the beginning of a period comparable to the currency’s early years, when trades ranged from 82 cents to 1 dollar against the euro.

Then, in the early 2000s, before the euro existed in the form of notes and coins and was just a virtual currency, the low exchange rate undermined confidence in the new currency. The European Central Bank even intervened to try to strengthen it.

Today, there are fewer questions about the resilience of the euro as progress has been made in strengthening the union. The central bank’s commitment to preserving the currency a decade ago has not been significantly tested since then.

But the weaker currency is causing additional headaches for the European Central Bank, as it will increase inflationary pressures in the region by raising import costs. Central bankers say they are not pursuing an exchange rate level, but it will be difficult for them to stop the currency’s decline with words because the forces pushing the dollar have been so strong.

With inflation in the United States near its highest level in four decades, the Federal Reserve has stepped up monetary policy with steep rate hikes. Fed chairman Jerome H. Powell said at a conference in late June that he expected the benchmark to rise to 3.5 percent this year. He added that there was a risk that the central bank would go too far in raising interest rates to cool the US economy, but that there was a greater risk of keeping inflation high.

As Mr Powell spoke, he sat next to Ms Lagarde at the European Central Bank’s annual retreat in Sintra, Portugal. While she agreed with him about the risk of continued inflation, she couldn’t match his commitment and clarity about how high interest rates could rise in the eurozone. Investors can only speculate about what might happen by the end of the year.

But even before the first rate hike on July 21, the growing risk of a recession in the eurozone is leaving investors wondering how much the bank can raise rates before shutting down again.

“The ECB will struggle to keep up with the determination the Fed has in tackling inflation or raising interest rates,” said Citi analyst Mr Rahbari.

As the European Central Bank plans its rate hikes, it should also keep an eye on government bond markets. There were concerns about the impact of rising interest rates and the end of the central bank’s bond-buying programs on the most indebted bloc members.

In Italy, for example, borrowing costs rose sharply in June, and officials are trying to determine to what extent those moves fairly reflected the risk of Italy’s financial situation and so-called fragmentation, or rapidly diverging interest rates across the eurozone. members that would make monetary policy less effective. The bank is preparing a new policy tool to address that fragmentation, which central bankers see as a breach between economic fundamentals and government borrowing costs.

“It will be another test time for the eurozone” and its central bank in the coming year, Mr Rahbari said.