Chart Of The Day: Euro To Resume Slide Below Parity

 | Aug 17, 2022 09:00AM ET

h2 Fundamentals

While Eurozone inflation surged to US levels, the euro has three primary disadvantages versus the dollar:

  • Interest rate differentials
  • Recession
  • Ukraine conflict
h2 Interest Rate Differentials/h2

The ECB surprised markets on July 21 with a 0.5 percentage point rise in its first increase in 11 years—to the whopping rate of...0%. The Federal Reserve raised on July 27 its second 0.75% hike in a row to over 2%. It does not look like the ECB will be able to catch up with the Fed rate soon.

Eurozone unemployment is 6.6%, nearly double the 3.5% in the U.S. Much higher unemployment leaves the ECB that much less room compared to the Fed to raise rates because of fears it will exacerbate unemployment.

h2 Recession/h2

Weak economic data this week strengthened the opinion that we are already in or heading toward a downturn, so the US dollar firmed. The currency is a natural haven for countries and companies facing currency uncertainty as it is the world's reserve currency and the denomination for many international business deals.

But, wait, doesn't a recession invalidate that?

First, there are still massive positive interest rate differentials for the dollar.

Second, hiring freezes and even downsizing to cut costs in preparation of economic tightening, and if this trend resumes, we could have increased unemployment.

The dangers of a stagflating economy are that it distorts businesses' investment decisions, and for consumers, it means that they may be unemployed or earning less while prices for everything are rising. So, they consume less, which hurts companies and causes a vicious cycle of unemployment and lower wages.

h2 Ukraine/h2

The Russian invasion of Ukraine directly impacts the euro area's economy. The European Central Bank said that beyond the "observable factors affecting economic activity" of "very high energy prices" and "renewed supply shortages," there are also unobservable factors from the associated rise in uncertainty shock.

h2 Technicals/h2

The supply-demand balance has favored the dollar for a long time. Here are just a couple of recent examples. On March 16, I forecast an eventual target of 0.84, the 2001 lows. Two months later, on May 16, I predicted that the euro would head to parity and even lower.

Now, let's get an update on what the forces of supply and demand are up to.