Oliver Mangan: Euro may move towards parity with the dollar

The euro is likely to test its lowest point of the past 20 years too, of $1.04, hit at the end of 2015

Mon, 02 May, 2022 - 17:00

The dollar made large gains in April, surging by nearly 6% in trade-weighted terms against a basket of major currencies. It has been a perfect storm in foreign exchange markets.

The US Federal Reserve has turned increasingly hawkish on monetary policy, with some its members signalling that a series of 50 basis point hikes may be needed over the summer to contain inflationary pressures.

The dollar has proved very sensitive to interest rates in recent years; it climbed to very high levels ahead of the Covid pandemic as US rates rose well above elsewhere.

The dollar then lost 12% against the other major currencies during 2020 as US rates were cut to virtually zero.

It has been on a recovering trend since mid-2021, as expectations grew that the Fed would tighten policy. The dollar has now more than recovered all the ground lost in 2020.

Other factors have also aided the dollar, including its premier safe haven status as the world’s main reserve currency at a time of elevated geo-political risks following the Russian invasion of Ukraine.

Market risk aversion has also increased due to fresh lockdowns in China to contain the latest wave of Covid.

Surging commodity prices have boosted the demand for dollars further, as commodities are largely traded in the US currency.

However, it is the much more hawkish rhetoric of the Fed on monetary policy compared to the ECB, Bank of Japan, and Bank of England that would appear to be the primary driver of dollar gains.

Markets expect the Fed funds rate to be raised from 0.375% at present to 2.75% by the end of the year.

By contrast, other central banks are much more cautious about hiking rates aggressively on concerns it could tip their economies into recession; indeed, the Bank of Japan is continuing with large scale bond purchases.

The Bank of England is anticipating a very sharp slowdown in the UK economy, signalling that just some further modest monetary tightening may be appropriate in the coming months.

Elsewhere, the ECB is still engaged in quantitative easing, with rate hikes to begin later in the summer.

Against the dollar, the euro has crashed through the key support levels. It is now likely to test its lowest point of the past 20 years too, of $1.04, hit at the end of 2015.

If these supports give way, it opens up a move towards parity for the dollar, which was last seen in 2002.

The previous time that the euro fell below parity, it spent almost three years there, from 2000-2002.

Overall, given the considerable divergence in interest rates that seems likely to be seen over the next couple of years, and that it is now anticipated the War in Ukraine will be drawn out, the current period of dollar supremacy could last some time.