Earlier this year, the Euro dropped to a 20-year low against the dollar and traded below parity against the dollar for the majority of September and October, before rallying in the last two months of the year to around $1.06.
So, when was the last time the euro traded below parity against the dollar?
The euro hasn’t been valued below $1 since July 15, 2002. The single currency hit its then all-time high of $1.18 shortly after it was officially launched on Jan. 1, 1999, but then began a long slide as the Fed started to hike rates aggressively to contain the relentless speculation on tech stocks (the dot-com bubble). The euro fell through the $1 mark in February 2000 and hit a record low of 82.30 cents in October 2000.
It rose above parity in 2002 as large trade deficits and accounting scandals on Wall Street weighed on the dollar. In the following 6 years, the euro staged a spectacular rally, reaching an all-time high of $1.6 in April 2008, which is then followed by a 14-year (and counting) correction against the dollar.
Why is the Euro dropping so hard in 2022?
Broad-based dollar strength - the Fed raised rates at the fastest pace in decades in 2022 to combat 40-year highs in inflation. Geopolitical uncertainties further pushed up demand for safe haven assets like the dollar and Swiss franc.
Euro weakness - Europe suffers the most from the Russian-Ukrainian war, which has sparked an energy crisis that could lead to potentially a long and deep recession. That placed the ECB in an incredibly difficult position - trying to curb double-digit inflation while cushion a slowing economy - as it raised borrowing costs for the first time in 11 years.
However, despite all the headwinds, the EUR/USD pair has rallied 12% since its late September bottom of 0.9540.
Catalysts for the Euro rally to continue
The research team at LHG, lead by Chief Investment Officer Laurence Yang, identified the following macroeconomic catalysts for the Euro to continue its appreciation:
Low valuation - The euro is still undervalued in PPP (Purchasing Power Parity) terms. While the Eurozone current account has deteriorated, it remains in surplus.
The pivot to a more hawkish stance by the ECB is drawing capital flows back to Europe — and its solution for peripheral Eurozone spread dislocation could enable the central bank to achieve a higher terminal interest rate, and better address the inflation threat.
Compared to the Fed, the hawkish surprise potential lies on the ECB's side and thus on the side of the euro.
On Friday December 9, Russian president Vladmir Putin suggested possibility of settlement to end war in Ukraine. The war has become too long, too costly for both Russia and Ukraine (and its western allies) and is unlikely to drag on for much longer. The end of the war is yet another potential upside surprise to the euro.
High speculative forward sales signal a stronger euro.
Meanwhile in the United States:
For once in over a year's time, the U.S. dollar showed at least some sustained weakness, with the Dollar Index (DXY) dropping around 10% from its late September peak.
The high twin deficit is a burden for the USD
There are signs that the Fed will probably refrain from further interest rate hikes in the near future, evidenced by the November Fed minutes which showed 'substantial majority' support slowing pace of rate hikes.
The recent increase in risk appetite on the financial markets decreased safe haven demand - including the dollar.
Laurence Yang's preferred trade: long EUR/AUD
Our Chief Investment Officer, Laurence Yang's preferred trade to capitalize the euro's further strength, is shorting the Australian dollar against the Euro.
Dovish Reserve Bank of Australia (RBA) - the Australian central bank is one of the most dovish central banks in the G10 group. When the Fed, ECB, BOC, BOE and most other central banks in industrialized countries delivered consecutive jumbo 50-75bp rate hikes, the RBA instead surprised the market, opted for the lower 25bp hike since October.
Australian rate traders are confident the end is near for this tightening cycle.
Australia’s 3-year yield is back down to 3%, as the yield curve flattens with RBA hikes seen slowing down the economy.
There is an increasing chance that the ECB will raise the key interest rate above the level expected by the money markets. In that scenario, the euro would appreciate even more significantly.
Current macro environment (including the widely anticipated recession in the US and Eurozone) is still unfavorable for high-beta currencies like AUD - a favorable global economic outlook is needed for sustained AUD appreciation.
Technical outlook of EUR/AUD
On EUR/AUD's daily chart, the 50-day moving average (the red line) crossed over the 200-day moving average (the blue line) - a "golden cross", suggesting further strength in the pair.
The pair has built the "double bottom" between April and September bottoms - another bullish signal for the pair.
In the near-medium term, the euro strength is likely to continue, correspondingly the USD has formed a near-medium peak;
While the RBA is set to slow down (even wrap up) rate hikes, the ECB is increasingly likely to catch up on consecutive (jumbo) rate hikes;
Global outlook remains unfavorable for high-beta currencies like AUD;
Long EUR/AUD with an upside target of 1.65-1.68.
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