Jeanne Asseraf Bitton

Jeanne Asseraf Bitton

Head of Market Research

Lyxor Asset Management


What’s happening with the euro-dollar parity?

22 May 2018

Active Strategies

Since mid-April, the dollar appreciated about 5% versus the euro. The move came as a surprise to many who thought that the euro-dollar pair was likely to converge towards purchasing power parity, currently estimated at 1.30 by the IMF. This rather consensual view was reflected in speculative positions on the euro that reached extreme levels on the long side, which in our view was a sign of rising vulnerability. But what triggered the move? Typical drivers of the pair include actual and expected trends in external accounts, growth and inflation dynamics and relative monetary policy.

Let’s examine those drivers. First, external trade with a massive current account surplus in the Eurozone facing a huge and worsening deficit in the US. The gap between the 2 is expected to widen, which would constitute a powerful drag on the dollar, but critically those expectations have not changed recently. Could we then attribute the euro weakness to the loss of growth momentum in the monetary union? Well, the recent Eurozone soft patch was unexpected as evidenced by the eye-catching drop in macro surprise indexes.

Meanwhile the US economy seemed resilient. The deterioration in relative growth dynamics could explain the currency move but the timing does not seem right: the euro held up well when the Eurozone macro backdrop was sharply disappointing, that is from February to mid-April. Since then, there may be some re-correlation at play with growth regaining center stage as a currency driver. But moreover, we believe that the euro-dollar pair is recoupling with interest rate differentials. The relationship loosened in the second semester Two Thousand Seventeen before reversing outright. 

The pair strengthened while the EMU-US interest rate gap turned increasingly negative, as if the forex market doubted that wide rate gaps could be sustained. The latest dollar upturn suggests that investors are repricing the odds that central banks will stay de-synchronized for long. Currency appreciation constitutes a barrier to reflation and the ECB might err on the dovish side to offset the negative impact on inflation of the euro past strength. Meanwhile, the Fed seems eager to continue its policy normalization as inflation moves back to target. What’s next? For the short term, the pair could test its technical support at about 1.16. Longer-term, we think that the US inflation picture will be pivotal.

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