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Traders are betting the euro will reach parity with the dollar as persistently high inflation and solid U.S. growth raise expectations that the Federal Reserve will start cutting interest rates in the coming months from the European Central Bank. There is a growing belief that the stock price could fall to even lower.
Investors have been buying options that pay out if the common currency falls below $1. Bank of America strategists said that based on the prices of these options, the market is currently pricing in a more than 10% chance of such a scenario occurring within the next six months. In early January, the market thought there was little chance of this happening.
The euro has already fallen 3.5% against the dollar since the beginning of January. A further drop of approximately 6.5% is required to achieve parity.
“Markets seem to be rebounding from the big U.S. interest rate cuts, but traders are pretty confident the ECB will start easing in June,” said Francesco Pesole, currency strategist at ING.
He added that the cost of betting on further euro weakness in options markets has “increased quite dramatically recently.”
Stubborn inflation and signs of solid growth in the United States have traders scaling back bets on how quickly borrowing costs will fall in the world's largest economy. Traders are currently pricing in less than two quarters of rate cuts from the Fed this year, compared to more than six quarters expected at the end of last year.
In the euro area, by contrast, the annual pace of inflation fell to 2.4% in March, moving closer to the ECB's 2% target, but growth also remains relatively weak. The IMF said Tuesday that the U.S. economy is on track to grow 2.7% in 2024, more than three times faster than the euro zone.
Concerns about escalating conflict in the Middle East and the potential knock-on effects of soaring oil prices have also raised warnings about the hit to the common currency, on which Europe depends on energy imports.
The last time the euro fell to parity with the dollar was in 2022, the first time in 20 years, due to energy price shocks triggered by Russia's full-scale invasion of Ukraine and a massive bull run in the dollar. It was in the middle of the day.
“The U.S. economy hasn’t even landed yet.” [weakening] And the risk of rising oil prices is also increasing. This has dramatically increased the risk of further depreciation of the euro-dollar to parity,” said Athanasios Vanvakidis, global head of G10 foreign exchange strategy at Bank of America.
ECB President Lagarde told CNBC on Tuesday that the central bank would monitor oil prices “very closely” but said market reaction after last weekend's Iranian air strikes in Israel had so far been “relatively calm.” It pointed out.
Signs of tensions in the Middle East could also push the dollar higher, as investors tend to value the safety of the dollar in times of stress.
Deutsche Bank and JPMorgan said they would take more moderate action once the ECB starts lowering borrowing costs, as interest rate differentials could cause the common currency to depreciate too much, pushing up the prices of imported goods and risking another spike in inflation. It warns that you may have to take.
However, Jane Foley, head of currency strategy at Rabobank, said the ECB may not oppose a gradual weakening of the euro as it begins to “focus more on growth risks than inflation risks”.
Mr Foley said weaker exchange rates could help exports, and the boost to growth would be particularly welcome for regional countries such as France and Italy, which suffer from rising government deficits.
