Problems in the eurozone could cause the euro to drop below parity with the dollar.
A significant theme in the financial press has been the story of “de-dollarization” as many analysts expect the dollar to play a less critical role in the global economy over time. This narrative implies that less demand for dollars will gradually weaken the US currency in the coming months and years. However, in the short run, there are important reasons why the dollar could move higher against the euro. Over the last year, the euro (EURUSD) moved up over 16% from its 2022 low (0.9536). After touching 1.1275 in mid-summer of 2023, the euro reversed course and closed lower for ten consecutive weeks for a loss of nearly 6%. It is now approaching its weakest level of the year, which may continue to trend downward in the next 6 months for the euro.
Reasons for further depreciation of EURUSD:
- Weak growth. The eurozone is still experiencing ongoing damage due to Russia’s disruption of global energy markets. Europe is struggling to find new energy sources in lieu of Russian imports. Additionally, a cooler winter this year could cause a spike in demand for natural gas and contribute to a slowdown in European economic growth as energy prices move higher. Eight EU (European Union) countries experienced economic contraction in early 2023, and growth continues to be weak
- Inflation continues to fall as the European economy is plagued by slow growth. This may lead the European Central Bank (ECB) to lower interest rates sooner than expected, causing the euro to slip against the dollar.
- Fiscal Dominance: This term refers to a situation where fiscal policy influences monetary policy. Countries may issue new debt to pay for programs intended to ease the hardships associated with slow growth. If the ECB is forced to monetize this debt, the euro would likely drop in FX markets. The ECB continues to face the balancing act of managing the disparate needs of nations that are separate fiscal entities.
- Negative Technical Structure: The euro has dropped nearly 6% from its recent high, closing lower for ten weeks in a row. In mid-August, it broke a support trendline going back to October 2022. Other technical indicators have turned negative as the 50-day moving average is poised to drop below the 200-day moving average, a chart pattern that technicians call the “Death Cross.” This pattern last occurred in July 2021 and the euro lost over 18% during the following 15 months.
Trend-following hedge funds have been establishing short positions in the euro during the last few weeks. The Economist’s well-known Big Mac Index lists the euro as being one of the few currencies that is currently overvalued against the dollar.
Predicting future currency prices is a difficult task, and many economists disagree with expectations that the euro will weaken. Virtually all agree that FX markets will continue to remain volatile in the quarters ahead, meaning that companies who do business with Europe should be prepared for currency price movement due to the potential euro forecast over the next 6 months. As we have already seen this year, the strong dollar is cutting into companies’ overseas revenue.
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