"Stronger USD VS Weaker EUR", Implications and Reasons Behind the Reverse - 2022-08-01
1 EUR = 1 USD! The historic equation that emerged on the European foreign exchange market on July 12th quickly became a global hotspot, marking the first time that the euro was at parity with the US dollar since December 2002. The euro even fell below parity with the dollar in European foreign exchange market trading on the 13th (local time). If the euro were a plane, it would be time to sound the alarm, commentators said. What does it mean to be equivalent to the dollar for a young currency that is only "23 years old"?
Who's the key player behind it?
Currently, the euro is still hovering near parity with the dollar. In fact, it has lost more than 11% in total this year.
Against the background of the world's major currencies weakening against the US dollar, a weaker euro is just one piece of the puzzle. However, as the euro has been seen as a potential challenger to dollar hegemony, its weakening caused particular concern.
The constant decline of the euro's exchange rates is thought to be related to a number of factors.
The first one is volatile geopolitical situation. The conflict between Russia and Ukraine and the sanction war between the West and Russia have triggered the energy crisis in Europe and caused high inflation in the eurozone countries. Inflation in the eurozone has now reached 8.6%. Amid worries over the energy crisis and a slowdown in the economy, investors have turned to the dollar as a safe haven.
The second factor is different US and European policies. The Federal Reserve is aggressively raising interest rates to curb the highest inflation in 40 years. Its interest rates have been raised to 1.5%-1.75% and the dollar has risen along the way. By contrast, the European Central Bank that is facing high inflation too has taken no action so far, with its short-term policy rate remaining at -0.5% due to the risks of economic recession and sovereign debt. As a result, the spreads between the dollar and the euro have widened, making the dollar more attractive to investors than the euro, which is under constant shorting pressure.
The third factor is the risks of economic recession. The eurozone's economy has not fully recovered from the shadow of the pandemic, and the Russia-Ukraine conflict sent new bombs: energy crisis and high inflation combined with low growth stagflation. Besides, the European Central Bank is stranded in a difficult situation and dare not raise interest rates. All of them have increased the risk of economic recession in the eurozone and thus dragged down the euro's trend.
Xu Mingqi, a specially-appointed researcher at Shanghai Institute of International Finance and Economics and Vice Chairman of China Center for International Economic Exchanges Shanghai Branch, pointed out that the euro's depreciation stemmed directly from the euro being sold off on markets, which was caused by multiple reasons: spreads triggering speculative profit-seeking actions, financial institutions taking advantage of the chaos to short the euro, pessimistic expectations of the euro, etc. But the more fundamental factor is that the eurozone itself has structural flaws in both its economy and currency, which makes the eurozone weak in risk resistance, less resilient in economy and more vulnerable to changes in external conditions.
From the economic point of view, the economic development levels of the member states vary, and the overall competitiveness and innovation capabilities are weak. For example, they lag behind in the information industry and other high-tech fields relatively. Strict laws and regulations, government supervision, and generous labor welfare also constitute hidden costs that restrict economic development to some extent.
In terms of currency, the euro is a unified currency created from the transfer of monetary sovereignty by different sovereign states. Despite the formation of a unified market, the fiscal, taxation and other economic policies are not unified, which is not conducive to a coordinated response to external risks in the eurozone.
Looking back at the development history of the euro in the past two decades, we see the trend of its exchange rates has been quite uneven. At its low ebb, when the US dotcom bubble occurred in 2000, the euro fell to a record low of 1 to 0.84 against the dollar. After the global financial crisis, the euro entered a period of intense volatility, hovering at low levels in 2015 and 2016, even near 1 to 1 at one point. At its peak, as the dotcom bubble burst, the euro rallied continuously, and even rose to a record high of 1 euro to 1.6 dollars in the financial crisis of 2008. "It's rare for the euro to fall to parity with the dollar, but not unprecedented. The fact that the euro fluctuates significantly suggests that the euro tends to be affected by its own economic performance, changes in the external environment, etc.," said Xu Mingqi.
Tan Yaling, President of China Forex Investment Research Institute, believes that the euro's current depreciation certainly has internal and external factors, but the United States is obviously a key player behind it.
Given the current situation in the eurozone, the euro's depreciation is clearly a disadvantage for the euro. Expectations of recession have already appeared; interest rates of the euro are sharply different from those of the dollar; and the region is facing a threat posed by the conflict between Russia and Ukraine. In this background, only when the currency remains stable or even rises can it help. But at this moment, the euro has fallen to parity with the dollar, while the latter continues to rise, which is worth some thoughts.
In Tan Yaling's view, the devaluation of the dollar is the basic national policy of the United States. But in the current situation, the United States cannot devalue its currency directly, as inflation is running high; an increase of interest rates is strongly expected; the employment indicators are optimistic; and consumption hasn't fallen completely. So the United States took an unusual path and boldly strenghtened the dollar. As a result, the euro and other currencies could only be devalued to meet the appreciation of the dollar.
Besides, the euro's current depreciation is also related to the price increase of energy and other bulk commodities. It is a shrewd move by the United States. Much of the eurozone's current inflation plight is imported inflation, stemming from the exported inflation designed by the United States for the euro. Both the United States and Europe are facing high inflation, but the former is resilient. For example, the US economic competitiveness and consumption have not been affected by high inflation. More importantly, the United States can control oil through pricing, and it has its own rich energy reserves. But oil and gas are Europe's weak sides. Actually, the United States has used its advantages to hit Europe's weakness, aiming to strangling the euro, which is in line with its long-term strategy of maintaining dollar hegemony and weakening the euro.
Will the parity threshold be crossed?
After the psychologically important 1 to 1 threshold was touched, the euro's following trend has drawn increasing attention. At present, opinions still vary about whether the parity threshold will be crossed.
Bearish believers think the fall to parity may be just the beginning of the euro's decline.
Nomura Securities predicted that the euro was expected to fall to 0.98 against the dollar, or even slip to 0.95, due to the unsolved energy crisis and deepened fears for economic recession.
"The worst-case scenario (a complete Russian gas cutoff to Europe) would lead to a recession and the euro could fall another 10 percent from its current level," FX strategist Kit Juckes at Societe Generale said in a report.
But rebound believers consider the euro-dollar parity as the bottom.
FX strategist Brad Bechtel at Jefferies Group said the euro was oversold against the dollar in terms of many technical indicators and parity was the target of many investors in the market. So he thinks the euro is likely to rebound in the short term.
According to Tan Yaling's judgement, the euro will still rebound. She thinks the euro is still supported considering the economic fundamentals. The eurozone economy saw an YoY growth of 5.1% and a QoQ growth of 0.3% in the first quarter. And GDPs of the major countries show positive growth." That is very important, but ignored by those hyping the devaluation of the euro."
"Moreover, the current devaluation of the euro has seen no lack of deliberate tactics used by the United States, that is, pulling the euro down before making it rebound, with the ultimate aim of helping with devaluation of the dollar." Tan said the Federal Reserve would hold a monetary policy meeting on July 28. It is almost certain that their interest rates will continue to be raised by 75 basis points. Investors may watch for future market trends. The dollar may be devalued to absorb the pressure from the Federal Reserve's interest rate hikes, and the euro will rebound accordingly.
Xu Mingqi thinks the euro’s exchange rates may continue to decline given that the factors causing the euro's weakness will not be eliminated in the short term. Also, the devaluation of the euro will bring uncertainty to the economic and financial situation, could trigger turmoil in financial markets and increase the risk of economic recession. This would make the euro more vulnerable and subject to downward pressure.
"Still, even if the euro falls below 1 to 1 against the dollar, it shouldn't fall to the all-time low of 2000." According to Xu Mingqi, back then the market had too many doubts about the nascent euro and the US dotcom bubble peaked. It resulted in a crazy flow of funds to the United States and a tide of selling off the euro, so that the Federal Reserve and the European Central Bank teamed up to intervene in the exchange rates. At present, although aggressive interest rate hikes in the United States have pushed up the prices of dollar assets, the risk of economic recession in the United States is also rising, and the US stock market has entered a bear market overall. So it is unlikely that huge amounts of funds will flow into the United States as they did in the past. Besides, the development of Russia-Ukraine conflict is also an important factor affecting the trend of the euro. If peace talks can be held or even compromises can be made in the future, market expectations will change and the euro will come out of the downturn and rally slowly.
Interestingly, the European Central Bank will hold a meeting on interest rates next week and may announce its first interest rate hike since 2011 to curb high inflation in the eurozone. The extent and pace of interest rate hikes by the ECB are also thought to have an impact on the euro's trend.
Implications of the reverse
Since its inception in 1999, the euro has been seen as the biggest rival to dollar hegemony. For 23 years, the euro has generally maintained its strength against the dollar despite the ups and downs . Now, for the first time in two decades, a reversed scene of "stronger dollar VS weaker euro" has appeared. What does it mean?
In Tan's view, the euro falling to parity with the dollar for the first time in two decades is an important signal of the change in the competitive dynamics between the US and European currencies.
According to Tan, the advent of the euro is the biggest challenge and threat to the dollar, and it is also a model for regional currencies, so the dollar has always regarded the euro as a thorn in its side. So far, possibilities of generating a regional currency have become increasingly low, and the currency competition between the United States and Europe has heated up. The sharp depreciation of the euro against the dollar shows that the dollar's position, influence and control over the landscape are expected to intensify in the future. The currency competition between the United States and Europe has not yet reached the point of challenging, substituting and altering the current landscape.
"For 23 years, the euro's share in foreign exchange reserves and foreign exchange transactions has been declining, not rising. This shows that both the credibility of the euro itself and people's confidence in the euro have been declining. Now that the euro has fallen to 1 to 1 against the dollar, it means even worse prospects for the euro." Tan said the outlook for the euro was not optimistic.
Xu Mingqi pointed out that the sharp depreciation of the euro would further weaken the euro's status as an important international currency. In one sign, the IMF adjusted the weights of five currencies in the SDR Basket in May. Among them, the weights of the dollar and the Chinese yuan have been increased, while the euro, the Japanese yen and the British pound reduced, indicating that the euro's status as an international currency is declining, in the short term at least. If the euro's exchange rates continue to fall, it will put the euro at a disadvantage in the international currency competition.
Regarding the recent collective devaluation of the euro, yen, pound and other currencies against the dollar, Tan Yaling also reminded that at the beginning of the third quarter, the international financial market was violently volatile, so the market needed to guard against the risks that could arise from the change of the dollar from appreciation to depreciation in the future, and be on the alert for the financial risks accompaning the global economic downturn.
The author is Xu Mingqi and Tan Yaling.
Xu Mingqi, Specially-appointed researcher at Shanghai Institute of International Finance and Economics and Vice Chairman of China Center for International Economic Exchanges Shanghai Branch.
Tan Yaling, President of China Forex Investment Research Institute.
Source: Shanghai Observer
Application Status
| 04-16 | 21315227 | Processing |
| 03-12 | 21315226 | Processing |
| 09-26 | 21315225 | Processing |
Inquiry Status
| 02-29 | 02131558 | Received |
| 03-06 | 02131557 | Received |
| 11-14 | 02131556 | Received |
FAQ
Q: Q: Is there a place where I can get...
A: A: Log on to http://touch.shio.gov....
A: A: Log on to http://touch.shio.gov....
Q: Q: What is the easiest way to set u...
A: A: 1. Log on to http://touch.shio.g...
A: A: 1. Log on to http://touch.shio.g...
Q: Where can I get an English map of S...
A: English maps of Shanghai are availa...
A: English maps of Shanghai are availa...
