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June 5th 2010

EUR/USD: The Next Benchmark is Parity

The Euro has now declined for six consecutive months against the Dollar. It is down 25% from its 2008 high and 15% in the year-to-date. It declined 8% in the month of May alone. En route to a four year low, the Euro also fell below the 50% retracement level ($1.21) of its rally from 2000-2008. It’s now too clear where the Euro is headed: parity.

eur usd 1 year chart
That’s right. Parity. We’re not talking about the Canadian Dollar or even the Australian Dollar. We’re talking about the Euro, which only yesterday was trading at a lofty $1.60 against the Dollar. According to CLSA Asia Pacific Markets, “The euro will sooner or later go to parity with the U.S. dollar.” Meanwhile, “The research firm Capital Economics predicts that the euro will reach par with the U.S. dollar by the end of next year.” There wasn’t even a perfunctory attempt by either firm to justify the prediction. Given the way that the Euro has been trading, it probably wasn’t necessary.

Since the last time I reported on the Euro, the bad news has continued to pour in. Spain officially lost its AAA credit rating, and concerns are mounting that the crisis is spreading to Hungary (not even on the radar screen last week) and Italy: “While Italy may not be as structurally vulnerable as Greece or Portugal, the relative underperformance of Italian credit default swaps this month suggests that investor concerns may be rotating away from Greece.” As if it wasn’t bad enough that investors had lost confidence, now banks won’t even lend to each other.

The $1 Trillion bailout, meanwhile, has done nothing to assuage the markets. “The markets are trading in real time, while the politicians are moving in bureaucratic time. We’re promised something maybe in October — that’s a hell of a long time in the financial markets’ eyes,” underscored one economist. Germany appears to be isolating itself from the rest of the EU, thanks to its ban on the short-selling of certain financial movements- a move that was not matched by other member states. “Concerns are also growing because Belgium is unlikely to have a government in place when it takes over the EU presidency on July 1 and markets are worried the EU’s institutions and leaders are ill-equipped to handle a crisis of this magnitude.”

The main issue, which critics of the bailout have been quick to point out all along, is that the fiscal problems that precipitated the crisis are still extant. Spain, for example, currently has the third largest budget deficit in the EU, and yet, it is struggling to make meaningful cuts and pass the necessary “austerity measures.” Germany has tried to unilaterally amend the EU treaty in order to force member states to balance their budgets, but to no avail. If a full-blown crisis is to be avoided, significant structural reforms will have to implemented, and soon.

For many, that the crisis will not be resolved is a foregone conclusion, and they have instead embraced the possibility of ECB intervention to stem the Euro’s decline. The last time the ECB intervened was in 2000, shortly after the Euro was introduced and when it was trading around 87 cents to the Dollar. Experts are divided over whether intervention is likely or even possible. Some have thrown out $1.10 or $1.00 has hypothetical levels at which the intervention would be likely, but the fact of the matter is, no one knows. Any intervention would necessarily involve the Fed and the other important Central Banks of the world. Don’t forget that when the Euro collapsed at the onset of the credit crisis, the Fed quickly underwrote a series of swaps to the ECB, and it could prove to be a willing participant this time around.

Recent History of Currency Intervention- Dollar, Euro, Yen

The ECB is naturally being coy, with President Jeane-Claud Trichet declaring: “Let us be clear, it is not the euro that is in danger.” Its monetary policy is still extremely accommodative, via low interest rates and a form of quantitative easing. This makes it favorable for investors to bet against the Euro, and is starting to earn the ECB the ire of EU politicians and economic policymakers. Given that the Euro’s decline has become self-fulfilling, pressure on the ECB will continue to mount, until the Euro reaches parity, and/or it has no choice but to intervene to prevent the common currency (and its raison d’etre!) from collapsing entirely.

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Posted by Adam Kritzer | in Central Banks, Euro, News | 4 Comments »

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4 Comments of “EUR/USD: The Next Benchmark is Parity”

  1. David - Forex Trader Says:

    Shocking as it seems, parity is possible. It’s been lower than that before and even if it hadn’t, just because it’s low doesn’t mean it can’t go lower.

  2. EU Crisis and Prospect of War Punish South Korean Won | Forex Blog Says:

    […] Forex « EUR/USD: The Next Benchmark is Parity | Home […]

  3. Manferd Says:

    Germany’s companies gain more sales from this ordeal. This may profit Germany but what about other countries? Do they gain more oversea order thanks to ‘cheaper’ euro rates?

    A lot of my friends are planning to go Europe for leisure. I am sure many Asian think the same way. Does this help Europe in the long run if the euro stay low?

  4. Euro Rally only Temporary, due to Short-Squeeze. | Forex Blog Says:

    […] 4%. I guess that means the Euro has been rescued from parity (which I characterized as “inevitable” on June […]

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