What Lies Ahead for the Euro to Dollar
With a three-percent gain over last month, the euro to dollar certainly looks like it’s on a path to recovery. Another encouraging sign is that the EUR to USD exchange rate finally broke above its 200-day moving average, but I would caution the bulls to hold back their optimism.
I don’t think the recovery is going to last. Let me explain…
The EUR to USD exchange rate, which is to say the relative strengths of the euro and U.S. dollar, has become a reflection of two differing approaches to monetary policy. Think about it as the Federal Reserve versus the European Central Bank (ECB). (Source: “Markets lose faith in the ECB as mass stimulus measures falter,” The Telegraph, March 10, 2016.)
Both central banks chose a path in the aftermath of the financial crisis and it’s led them to very different outcomes. If we want to figure out where the EUR to USD is headed, we need to figure out what the heck they did in the first place.
After Bear Stearns and Solomon Brothers collapsed, we knew there were going to be gaping holes in both the American and European economies. The global financial system was too closely intertwined for either side to be insulated from the damage.
Moments like these are when central banks are supposed to start printing cash and cutting interest rates. The Federal Reserve went full throttle on its emergency measures, rolling out a bond-buying program of epic proportions and slashing interest rates to near zero.
Things went differently on the other side of the pond. Germany has a lot of political influence over eurozone policymaking and its history with hyperinflation makes Germany want to avoid excessive money printing at all costs. So the ECB was relatively hands-off in the post-crisis era, even when the sovereign debt crisis hit a few years later.
Mario Draghi—who got the top spot at the ECB during Greece’s first brush with insolvency—promised to print more money if things got worse. He made that commitment at a time when volatility was spiking in European markets. It worked.
His promise for action was, for the moment, enough to calm down investors. The EUR to USD remained buoyant, but as time wore on, the exchange rate began to slip. America’s economy was healing because the Fed had plugged the hole early on; it staunched the bleeding while the wound was still fresh.
Contrast that with Europe—where Italy, Greece, Portugal, and Spain were approaching bankruptcy—and it’s no surprise the euro to dollar started slipping. The exchange rate was hovering at approximately $1.45 around then, but it’s closer to $1.13 today.
One of the biggest drops in the exchange rate came last year when the ECB decided to (finally) go full throttle on its money printing. It churned out €60.0 billion each month to stop Europe from slipping into recession and it still didn’t work.
Earlier this month, Draghi was forced to increase the stimulus package to €80.0 billion and push interest rates into negative territory. He’s all but guaranteeing further losses in the euro to dollar exchange rate.
The only reason we’re seeing some support in the EUR to USD right now is because markets are disappointed the Fed didn’t raise interest rates again this month. But Janet Yellen still seemed confident about at least one more rate hike in 2016, so I wouldn’t get too comfortable with these momentary gains.
The EUR to USD could easily hit parity by the end of the year.