MacroscopeEuro is no safe haven as China seeks to reduce its dependence on US dollar

The euro has touched parity with the US dollar, and pressures such as the war in Ukraine, global energy crisis and credit woes could further dent sentiment

China appears to have few other good options as it seeks to allocate its massive forex holdings

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An employee shows Croatian kuna and euro banknotes at a currency exchange office in Dubrovnik, Croatia, on July 23. The euro is under increasing pressure on multiple fronts. Photo: Bloomberg

Published: 1:30am, 16 Aug 2022

With heightened geopolitical tensions in Europe, should China consider diversifying its currency risks away from the euro? The euro has already tested parity against the US dollar in recent weeks, and the big question is how much lower it might go as the odds stack up against it.

The war in Ukraine, global energy crisis and the risk of another European credit event could easily sink the euro back to its historic low versus the dollar if sentiment flounders again. But Beijing is stuck for choice as there are few places to turn other than the US currency, which might not be the best option when the longer-term intention is to limit China’s dependence on the dollar.

When international trading conditions become more challenging, global investors tend to mitigate risk by diving for cover into safe haven currencies. These include the US dollar, the Swiss franc and the Japanese yen.

During the recent market upheaval, the US dollar has stood head and shoulders above the field. This is thanks to lower proximity risk, the relative strength of the US economy and the fact the Federal Reserve has shifted to an aggressive approach of monetary policy tightening.

Thanks to the United States’ rising interest rate premium over other currencies, the dollar’s trade-weighted index against a basket of other major currencies has risen as much as 21 per cent since January 2021, as safe-haven demand has surged. Dollar bulls have been well rewarded for their risk aversion.

It is hard to ignore the dollar’s relative yield appeal. With the Fed looking likely to raise interest rates as high as 4 per cent by 2024 – and possibly higher if inflation difficulties persist – the dollar’s relative interest rate advantage will only get stronger. In the money markets, the dollar carries a 2.28 per cent premium over the yen, 2.35 per cent over the euro, and 2.53 per cent over the Swiss franc.