The Strategist

Analyst: euro-dollar parity will shock the US and Europe

12/01/2016 - 14:29

Both sides of the Atlantic may soon face a perfect storm that could push value of the euro to the lowest level in 15 years. By the next autumn, four largest member states of the Eurozone will determine whether wave of populists and anti-globalists will wash away foundations of centrist government. Italian Prime Minister Matteo Renzi has tied his political fate to the constitutional reform referendum, which will be held this Sunday. Netherlands are choosing a new parliament on March 15; the first round of the French presidential elections is scheduled on 23 April; elections to the German Bundestag are starting in autumn. These four events will cause unprecedented tension in the currency markets.

Dennis Skley
Dennis Skley
Faith in ability of Europeans to strengthen their common currency by decisive reforms and economic recovery has not grown for seven years since the Greek crisis began.

In the United States, in turn, coincidence of two factors leads to a sharp increase in dollar. First, the Federal Reserve is likely to raise its key interest rates in December. This extension away from the zero interest rate policy will make the US dollar and related securities more attractive to foreign investors. Second, the growth would probably be pushed up by intentions of the US President-elect Donald Trump, to invest in modernization of the US infrastructure.

It is unclear whether Trump will be able to enact this unpromising plan as the Congress is dominated by Republicans. However, the very prospect of American boom and fiscal incentives is promoting growth of the dollar. After Trump won the elections on 8 November, the euro has lost more than five percent of its value against the dollar.

Société Générale expects that the euro and the dollar will align in the first three months of the new year. Last time this happened in 2002. Bloomberg News asked currency traders about whether the euro will fall to the dollar’s level by the end of 2017. In total, traders assessed possibility of such a scenario at 43%. "Trump’s victory changed the situation", - wrote Market Strategist George Saravelos of Deutsche Bank.

However, change of the euro-dollar ratio can have paradoxical consequences for future of Europe and the United States.

Low value of the euro hurts not only European exporters. This would also mean increased cost of imports, particularly for oil, traded in dollars. Thus, the euro and US dollar equation will lead to higher prices in the euro area. This, in turn, will force the European Central Bank to stop invest billions of dollars in securities. This measure was designed to stimulate sluggish economy and barely noticeable inflation. Moreover, given rise in price, rejection of the zero interest rate policy would be a reasonable next step.

As for the US, rise of the dollar will impede Trump’s attempts to fulfill his election promises to return displaced overseas jobs to the US enterprises and increase wages. The dollar's rise not only boosts prices of US exporters’ goods. It helps reduce cost of foreign competition. In this conditions, there would be only two ways out – to replace people with robots, or move enterprises abroad.