The US dollar is gearing up to bludgeon the euro back below parity very soon
Sixteen years on from the euro’s first dive below parity, the greenback is on a roll while the European currency is growth-starved
History has a habit of repeating itself and in the case of the euro-dollar exchange rate it looks like Groundhog day for the euro returning back below parity fairly soon. The dollar is on a roll, the dice is loaded and the euro is in trouble. It is 2000 all over again and the euro bears smell blood.
Sixteen years on from the euro’s first crash dive below parity, the circumstances are a little different but the results will be the same. Then, it was all about the dollar gearing up on better relative fundamentals, the fledgling euro struggling under a cloud of uncertainty and the forex markets going for the new currency’s jugular, goading the global authorities to react.
Back in 2000, US dollar sentiment was being pumped up by a host of positive factors. Stronger GDP growth and more attractive interest rate and bond yield differentials were all working in the dollar’s favour. The US ‘Dot.com’ stock market frenzy was also stoking up demand for dollars.
By contrast, at the time, the euro was struggling. The currency was bogged down by lacklustre European growth, weak relative yield appeal and crippled by strong capital outflows from Europe into more alluring US markets. Investors also took a dim view of the euro’s short term track record, having only come into existence the previous year. It was untried and untested. The euro’s break below parity with the dollar was quickly followed by a crash down to EURUSD 0.82.
Fast forward sixteen years and it is all happening again. The dollar has finally found its mojo after years of punishing debasement by quantitative easing and seems settled into a secular recovery. The dollar has had a better run for the best part of two years, but the election of political maverick Donald Trump as next US President seems to have given the dollar’s revival new impetus.
Forex markets are homing in on three major factors now – stronger US growth expectations, better relative yield appeal and an extended stock market rally. The centre-piece of Trump’s ‘America first’ strategy is good old-fashioned fiscal pump-priming, expected to double GDP growth, create 25 million new jobs and put more spending power in consumers’ pockets through generous tax cuts.
It is going to put the Fed under pressure to hike rates, and US debt markets are already feeling the heat, with the Treasury long bond yield breaching 3 per cent, the highest level for almost a year. This is yielding 2 per cent more than equivalent 30-year yields in the euro zone. With the US markets focused on stronger growth, higher rates and budget-busting fiscal reflation, it is no wonder the euro is on a hiding to nothing right now.
The euro is being growth-starved, flayed by negative interest rates and atrophied by austerity-bound fiscal policies being dictated by Germany and the European Union’s fiscal stability pact. What’s more, economic policymaking is in a mess and Europe’s political outlook is in turmoil.
Meanwhile, Europe’s economic growth outlook is imploding. Even German growth has collapsed to a meagre 0.8 per cent annualised rate. The European Central Bank seems in a dither about how to jump-start recovery and appears to be moving into deeper water in terms of more arcane, off-balance sheet monetary stimulus – always a worry for the straight-laced foreign exchange markets. The ECB’s quantitative easing monetisation programme is ripping the heart out of the euro.
But there is a deeper worry emerging for the forex markets – the existential risk of the euro not being around at some point in the future. The euro went close to the edge of extinction over the Greek debt crisis between 2010 and 2012 and it is not out of the woods yet.
The political landscape in Europe is in a state of deep flux. If the shock of the UK’s Brexit vote and Donald Trump’s surprise election has taught the markets one thing, it’s never to rely on the safe and easy outcomes. Key elections in Germany and France over the next year could see an end to the old euro-centric order and foreshadow a dangerous upheaval in European politics. Next week’s critical Italian referendum could be a major test for the euro in its downward descent.
One thing is very clear. Relative growth, interest rates, bond yields and politics are providing compelling pointers for currency markets. In the coming weeks, the dollar will be trampling the euro underfoot, pressing it down to new record lows.
David Brown is chief executive of New View Economics