Forex
The euro is at parity with the dollar. Why it happened and what it means for the economy
For the first time in 20 years, the euro has fallen to exactly one dollar. This was preceded by serious crisis phenomena in the European and American economies, and the change in exchange rates may be a consequence of a different response to the same crisis.
Why is the Euro falling?
At the moment, the euro is one step away from parity with the dollar – it costs about $1.0005 on world markets. The rate of 1 dollar to 1 euro has in fact already been reached.
The reasons for this are to be looked for from both sides – from the weakening of the euro and from the strengthening of the dollar:
- The dollar is rising on the back of the U.S. Federal Reserve’s tight monetary policy. The U.S. authorities are struggling with high inflation (it renews its highs every month), so the Fed is raising the interest rate at every next meeting. Higher interest rates make U.S. government securities more attractive to investors and this has a direct impact on the exchange rate. This is confirmed by the high value of the dollar index to other currencies (DXY);
- The euro has no reason to strengthen. The European Central Bank’s key rate policy remains soft – currently at minus 0.5%. EU countries are waiting for the ECB to take steps to raise the rate in order to fight inflation, and the rate may reach 0.75% by the end of the year. But so far this is not happening; inflation in the Eurozone reaches 8.6% (just like in the US), and the European economy is suffering from high energy prices.
Simply put, the reason for near parity is that the U.S. Fed is fighting inflation harder than the ECB. But the U.S. government debt service will become much more expensive for U.S. authorities, while European countries can still avoid unnecessary spending.
Among the reasons, experts call the current balance of foreign trade: EU countries have a negative (deficit of up to 1 trillion Euros) while the U.S. has a surplus.
What will be the consequences?
Among the obvious consequences of the weakening of the euro for the eurozone countries is the continued fall of the currency, a further increase in inflation, which will affect the standard of living in EU countries.
Experts predict the growth of tensions and economic problems in European countries:
- Today, achieved currency parity will not cause any significant consequences for the European economy. A fall below parity will signal the inevitable consequences of the energy crisis and the inevitable recession in the Eurozone. For U.S. companies, the weak euro means difficulties and problems with competitiveness in European markets.
- For European companies, a weak euro increases inflationary pressures through the rise in the cost of key imported raw materials for Eurozone companies. Theoretically, the weaker euro should be good for European exporters. At the same time, there are significant problems with energy supply in the Eurozone. This constrains the development of the investment potential of European industry for export. In addition, the weak euro reduces the attractiveness of assets denominated in European currency. As a result, investors will focus their investments in the United States.
Investing.com – The US dollar rose in thin holiday-impacted trade Tuesday, retaining recent strength as traders prepared for fewer Federal Reserve rate cuts in 2025.
At 04:25 ET (09:25 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, traded 0.1% higher to 107.905, near the recently hit two-year high.
Dollar remains in demand
The dollar has been in demand since the Federal Reserve outlined a hawkish outlook for its interest rates after its last policy meeting of the year last week, projecting just two 25 bp rate cuts in 2025.
In fact, markets are now pricing in just about 35 basis points of easing for 2025, which has in turn sent US Treasury yields surging, boosting the dollar.
The two-year Treasury yield last stood at 4.34%, while the benchmark 10-year yield steadied near a seven-month high at 4.59%.
“We think this hawkish re-tuning of the Fed’s communication will lay the foundation for sustained dollar strengthening into the new year,” said analysts at ING,in a note.
Trading volumes are likely to thin out as the year-end approaches, with this trading week shortened by the festive period.
Euro near to two-year low
In Europe, fell 0.1% to 1.0396, near a two-year low, with the set to cut interest rates more rapidly than its US rival as the eurozone struggles to record any growth.
The ECB lowered its key rate earlier this month for the fourth time this year, and President Christine Lagarde said earlier this week that the eurozone was getting “very close” to reaching the central bank’s medium-term inflation goal.
“If the incoming data continue to confirm our baseline, the direction of travel is clear and we expect to lower interest rates further,” Lagarde said in a speech in Vilnius.
Inflation in the eurozone was 2.3% last month and the ECB expects it to settle at its 2% target next year.
traded largely flat at 1.2531, with sterling showing signs of weakness after data showed that Britain’s economy failed to grow in the third quarter, and with Bank of England policymakers voting 6-3 to keep interest rates on hold last week, a more dovish split than expected.
Bank of Japan stance in focus
In Asia, fell 0.1% to 157.03, after rising as high as 158 yen in recent sessions, after the signaled that it will take its time to consider more interest rate hikes.
edged 0.1% higher to 7.3021, remaining close to a one-year high as the prospect of more fiscal spending and looser monetary conditions in the coming year weighed on the currency.
Beijing signaled that it will ramp up fiscal spending in 2025 to support slowing economic growth.
Investing.com– Most Asian currencies moved in a tight range on Tuesday, while the dollar extended overnight gains as traders positioned for a slower pace of interest rate cuts in the coming year.
Trading volumes were muted before the Christmas break, while most regional currencies were nursing steep losses against the greenback for the year.
Asian currencies weakened sharply last week after the Federal Reserve effectively halved its outlook for rate cuts in 2025, citing concerns over sticky U.S. inflation.
Dollar near 2-year high on hawkish rate outlook
The and both rose about 0.1% in Asian trade, extending overnight gains and coming back in sight of a two-year high hit last week.
While the greenback did see some weakness after data read lower than expected for November, this was largely offset by traders dialing back expectations for interest rate cuts in 2025.
The Fed signaled only two rate cuts in the coming year, less than prior forecasts of four.
Higher U.S. rates diminish the appeal of risk-driven Asian markets, limiting the amount of capital flowing into the region and pressuring regional markets.
Asia FX pressured by sticky US rate outlook
Most Asian currencies weakened in recent sessions on the prospect of slower rate cuts in the U.S., while uncertainty over local monetary policy and slowing economic growth also weighed.
The Japanese yen’s pair fell 0.1% on Tuesday after rising as high as 158 yen in recent sessions, after the Bank of Japan signaled that it will take its time to consider more interest rate hikes.
The Australian dollar’s pair fell 0.2% after the minutes of the Reserve Bank’s December meeting showed policymakers saw an eventual easing in monetary policy, citing some progress in bringing down inflation. But they still flagged potential upside risks for inflation.
The Chinese yuan’s pair rose 0.1% and remained close to a one-year high, as the prospect of more fiscal spending and looser monetary conditions in the coming year weighed on the currency.
Beijing signaled that it will ramp up fiscal spending in 2025 to support slowing economic growth.
The Singapore dollar’s pair rose 0.1%, while the Indian rupee’s pair rose 0.1% after hitting record highs above 85 rupees.
Investing.com — The dollar has surged past its post-2022 range, buoyed by U.S. economic exceptionalism, a widening interest rate gap, and elevated tariffs, setting the stage for further gains next year.
“Our base case is that the dollar will make some further headway next year as the US continues to outperform, the interest rate gap between the US and other G10 economies widens a little further, and the Trump administration brings in higher US tariffs,” Capital Economics said in a recent note.
The bullish outlook on the greenback comes in the wake of the dollar breaking above its post-2022 trading range, reflecting renewed confidence among investors driven by robust U.S. economic data and policy expectations.
A key risk to the upside call on the dollar is a potential economic rebound in the rest of the world, similar to what occurred in 2016, Capital Economics noted.
Following the 2016 U.S. election, economic activity in the rest of the world rebounded, while Trump’s tax cuts didn’t materialize until the end of 2017, and the Fed took a more dovish path than discounted, resulting in a 10% drop in the DXY on the year, which was its “worst calendar year performance in the past two decades,” it added.
While expectations for a recovery in Europe and Asia seem far off, a positive surprise for global growth “should be ruled out”, Capital Economics said.
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