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July 14, 2022

Huge: Making Sense of EURUSD Parity

Michael J. Donoghue
Huge: Making Sense of EURUSD Parity

The US Dollar Index (DXY) has surged this morning, up over 0.9% intraday as buying pressure pushes it above the 109 level for the first time in two decades. Yesterday, the Bureau of Labor Statistics revealed that month-over-month CPI in June clocked in at 1.3%, whereas 1.1% had been expected. This means that year-over-year inflation has hit 9.1% in the United States, identical to that in the United Kingdom, tied for highest among the G7 countries. Likewise, even Core CPI, which excludes volatile food and energy prices, reached 0.7% month-over-month in the US, whereas only 0.5% had been anticipated. This is extremely bullish for USD and reflects as such among the major pairs; in fact, it has even prompted EURUSD to briefly plunge below parity support today, testing the 0.995 level for the first time in 20 years. While it would be easy to pin this momentum entirely on demand for USD, in terms of fundamentals, the story is even more bearish for the pair than these new numbers indicate. Let’s juxtapose these two currencies’ circumstances as we engage in a newly revived discussion, the significance of which is huge: making sense of EURUSD parity.

USD Strength Factor #1: Holistic Hyperinflation

The US economy continues to overheat as sustained inflation accelerates. This may seem trivial considering how ubiquitous this phenomenon is; after all, even if the US is tied for the highest inflation rate in the G7, aren’t the countries’ inflation rates comparable enough, and their supply chains mutually globalized enough, that the exact numerical differences would be irrelevant? However, when we sift through the details, inflation in the US is particularly robust and nuanced.

In spite of a slight uptick in unemployment claims, the American labor market remains especially hot: high NFP numbers, a historically low 3.6% unemployment rate, and millions of unfilled job openings signal economic vitality, feeding strong demand. Likewise, US monthly goods trade deficits are hitting record numbers, consecutively surpassing $100 billion despite USD’s high value relative to other currencies; even Core CPI is beating market forecasts by big margins. These all signal strong US consumer spending that will continue into the near future, feeding inflation.

USD Strength Factor #2: A Hawkish Federal Reserve

The Federal Reserve, the United States’ central bank, has come a long way from the dovish institution that was dishing out monetary stimulus throughout the pandemic. Gone are quantitative easing and near-zero interest rates, replaced by quantitative tightening and steadily growing rate hikes. The Federal Open Market Committee (FOMC; the policy-making branch of the Federal Reserve) last implemented a rare 75 basis point rate hike in June, with Chair Jerome Powell signaling more aggression to come on a case-by-case basis, depending on the severity of inflation. Considering that inflation in the US continues to surpass market predictions, if FOMC dispositions and Powell’s warnings hold true, USD seems primed for further bullishness.

EUR Weakness Factor #1: Acute Energy Dependence

While the EU is likewise contending with hyperinflation concerns for many of the same reasons as the US, certain underlying economic conditions exacerbating eurozone inflation are particularly worrisome. For example, much of their energy supply is contingent upon oil and gas imports from Russia, which they now have limited access to due to economic sanctions, e.g., a partial embargo on Russian oil, and open potential for retaliation.

In 2021, Russia supplied more than 25% of the EU’s crude oil imports and approximately 45% of the EU’s natural gas imports (by contrast, Russia supplied only 8% of all US imported oil). This chronic dependence enabled the European economy to endure a relatively underdeveloped energy sector, until consequences from the invasion of Ukraine strained the trade partnership with Russia. This variable makes eurozone inflation particularly devastating because of the degree to which it is caused by severely restricted supply, not merely too much consumer demand. Combined with myriad other war-related risks, this is quite bearish for EUR.

EUR Weakness Factor #2: A Timid European Central Bank

The European Central Bank (ECB), the European Union’s central bank, has been hesitant to fully commit to a pivot towards hawkishness. Although they are gradually phasing out expansionary monetary policy via 25 basis point rate hikes (which is significant considering that negative interest rates were a precedent pre-COVID), they lag far behind their foreign central bank counterparts in terms of aggression, despite 8.6% year-over-year inflation. This caution may be for a variety of reasons, including stagflation worries related to their unsettling 6.6% unemployment rate, as well as economic advantages that come with a depreciating Euro potentially boosting European exports. Regardless, the ECB is walking, not running, towards a newfound hawkishness.

Will EURUSD Parity Become the New Normal?

Regarding a long-term valuation, it is impossible to say for certain whether EURUSD parity will become a guiding principle. However, due to the aforementioned fundamentals and differing trade advantages, there is a chance that EUR’s value exceeding that of USD by the margins of the last few decades could be a thing of the past, at least for a while. Considering the extent to which the global economy has been rattled, and the disparity between the Fed and the ECB’s trajectory of monetary policy decisions, it even seems plausible that EURUSD could experience a full breakout to the downside of parity support, discovering more selling pressure.  

Key Takeaways

  • According to newly released CPI numbers for June, month-over-month inflation hit an unexpected 1.3%, or 9.1% year-over-year in the US. This has caused demand for USD to soar, even dipping EURUSD generously below parity for the first time in 20 years.
  • A substantial component of USD strength is how holistic US inflation is. While supply chain issues are affecting US markets in a similar manner to other countries, a hot labor market, historic trade deficits, and rising Core CPI affirm resilient consumer demand.
  • Another integral factor promoting USD strength is how hawkish the Federal Reserve has become in recent months. Considering the severity of their recent rate hikes, and how sustained inflation continues to accelerate, more tightening likely lies ahead.
  • A critical problem exacerbating EUR weakness is the EU’s significant lack of a more localized energy supply. An acute reliance on importing Russian oil and gas has left them vulnerable to their own sanctions and any potential retaliation, limiting EUR bullishness.
  • Another issue facing the eurozone is the European Central Bank’s wariness of full-blown hawkishness. While they have pivoted in a sense, implementing a rate hike and departing from negative interest rates soon, they lag far behind many of their foreign counterparts.
  • EURUSD parity could become a new precedent long-term, especially considering the eurozone economy favors a cheap Euro for increased exports, and a strong US Dollar means cheap imports for the US. It currently seems probable that the pair will sink even lower.

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