Euro to Dollar Forecast for 2016 Is Decidedly Bearish
The euro to dollar forecast sees the EUR/USD exchange rate dropping in the forex markets, recently hitting its lowest point in the past seven months as the dollar reaches a high for the same period. (Source: “U.S. stocks jump, dollar hits seven-month high after Fed minutes,” Reuters, November 18, 2015.)
The technical analysis suggests that the euro is on a definite bearish path, where few bulls dare to tread. Indeed, the euro could not only reach parity with the dollar, but it could also drop even lower before the start of 2016. Why? Because the European Central Bank (ECB) has hinted that it would adopt new measures extending its expansionary monetary policy, rather awkwardly known as quantitative easing (QE).
The “Eurotower,” as the ECB is sometimes loftily nicknamed, is preparing to launch “QE2.” Not the famous Cunard cruise ship of the 1970s, that is, but a plan to intensify the current quantitative easing plan by injecting an additional €60.0 billion (US$64.0 billion) per month. (Source: “Hints get heavy for ECB’s hard task ahead,” The Financial Times, November 18, 2015.)
According to the Italian bank Unicredit, Draghi will raise the asset purchase program to $535 billion. Draghi’s plan also includes cutting the ECB’s deposit rate by 10–15 basis points from the current level of 0.25%. (Source: “EUR/USD drops to 1.0630 on expectations of QE2 and cut rates on deposits,” Forexinfo.it, November 17, 2015.)
The goal is to lift inflation to two percent over the medium-term to boost higher economic growth in the eurozone. Bank of America Merrill Lynch expects a QE increase as early as December, with a €10-billion (US $10.75-billion) boost in QE for a period lasting at least until September 2017. (Source: Ibid.)
Therefore, the EUR/USD outlook will continue to weaken in the coming months in view of the likelihood of higher interest rates in the United States (even if just slightly so), which is a move that is expected to be announced at the next Federal Open Market Committee meeting in mid-December.
Fed Rate Hike Is Bearish for EUR/USD Exchange Rate
The new generation of traders and financial analysts has never actually dealt with such a move and the novelty could carry significant shock value. This could potentially push the dollar to parity and beyond before year-end, which is sooner than the previous expectations predicting parity by the first quarter of 2016.
It was on January 1, 2000 that the Euro was formally launched with a EUR to USD exchange rate of $1.17, as half the world was busy worrying about the “millennium bug” (Y2K) hoax. Now, exactly 15 years later, the euro, Europe’s single-currency experiment, is heading to parity with the dollar.
Technically, it’s heading back to parity, because in October 2000, the EUR to USD exchange rate was in favor of the dollar, such that one euro was worth 82.3 cents. When the attacks against the Twin Towers in New York and the Pentagon in Washington DC came, they prompted the U.S. offensive in Afghanistan. By July 15, 2002, after 29 months, the euro fell back to parity with the dollar.
The euro achieved historical peaks against the greenback in July 2008. That month, the Fed cut rates to defibrillate the U.S. markets, which were starting to feel the effects of the U.S. subprime mortgage crisis that was still in its infancy at the time. Then-ECB governor Trichet was rather happy to allow rates to go up.
The EUR/USD Outlook for 2016
Now, the opposite effect is happening. The Fed is itching to raise rates, while the ECB is giving the impression it may be willing to go into negative rates, if only the move could ensure a higher inflation rate. Moreover, the ECB hopes that the super-low euro will help stimulate the puny European continental growth by way of exports.
Day by day, parity is getting closer at the relative speed of a French bullet train. The issue now seems to no longer be an “if” but a “when.”
If it hasn’t happened yet, it’s because the Fed has continually delayed the rate hike. The U.S. dollar could be above parity against the euro by the start of 2016. Analysts that are more conservative concur with the bearish ones—or bullish, depending on which side of the Atlantic they live—differing only in the timing of parity and the dollar’s surge past the euro. Conservative analysts are predicting parity to be achieved in the second quarter of 2016.
In the medium- and longer-term, however, if the ECB’s strategy works, a stronger European economy by the summer of 2016 will allow the euro to sustain parity, recovering any eventual losses to the dollar.
The ECB does have some data to support optimism. Recent macro statistics in the eurozone were better than expected and inflation in October showed a tentative recovery, even if it wasn’t sufficient in thwarting the effects of a Fed rate hike.
As for the Fed, the U.S. central bank’s move to bump the federal funds rate appears to be on track to increase in December. The addition of hawkish members to the Federal Reserve’s board, such as Bullard, George, and Mester, has changed the institution’s character and tolerance for the current rates. (Source: “Fed’s Mester, Bullard Say U.S. Outlook Justifies Rate Hike,” Bloomberg, August 28, 2015.) The Fed appears to be adopting the stance that by year-end, if rates remain at present levels, the euro could gain ground, rising comfortably above parity at $1.10 in the wake of the expected growth.
The dollar could gain proportionately more strength compared to the euro, even with a minimal Fed rate hike, because such a decision will be such a shock to the system, given its tortured gestation, that it will have an echo effect. In other words, the dollar will pull above its real weight. In addition, if the ECB’s quantitative easing plans fail to deliver the kind of recovery in the eurozone to reach Draghi’s inflation targets, the parity scenario would change to a dollar-euro reversal scenario. Some analysts predict a 0.965:1 ratio for the euro to dollar forecast.
Are the Days of a Single World Currency—the Globo—Over?
The pace of rate hikes and the euro/dollar exchange will become one of the main drivers of the markets in 2016. However, the markets will also feel the effects of the bombing attacks of November 13 in Paris, though not all are bearish on the EUR to USD exchange rate.
Stephen Diggle, a noted hedge fund manager, is bearish on the prospects of a dollar-euro exchange parity. (Source: “Hedge-Fund Veteran Says Euro Slide Almost Over, UBS Agrees,” Bloomberg Business, November 17, 2015.) Diggle, who now heads Singapore Vulpes Investment Management, said that the descent of the euro toward the dollar is almost complete, a EUR/USD exchange forecast that is also shared by UBS.
Despite, the fact that the EUR/USD forecast is in favor of the American currency and the thrust of European monetary policy remains expansive with excellent U.S. macroeconomic data, Diggle says the euro-dollar exchange will not reverse. In fact, Diggle believes that while the euro has plenty of more room to fall, the U.S. economy is not experiencing as much strength in its growth as some suggest; meanwhile, the European scenario is not as bad as many fear, because it is backed by Germany’s economic machine.
With all due respect to Stephen Diggle, the U.S. economy could make substantial gains in the short- and medium-terms because of the renewed growth of the defense sector in the wake of a wider campaign against the Islamic State and the rise of a more belligerent Europe. Meanwhile, the Volkswagen AG emission scandal has not yet delivered its consequences on what is Germany’s largest company. The potential layoffs and asset selloff could weaken VW substantially and take Germany with it.
In a slightly less bullish tone, where the EUR to USD exchange rate is concerned, Kelvin Tay, regional head of investments at UBS in Singapore, concedes that parity between the euro and the dollar is possible and that the Fed will cut interest rates in December, noting that this would not last very long. (Source: Ibid.)
It is still unclear how the Paris attacks will affect the markets’ performance; however, considering the attacks have shifted the course of geopolitics, the economic effects will not be delayed much more. The changes are especially difficult to predict in the short-term, as the situation remains fluid. What is clear is that trade patterns could change, including the application of sanctions, namely those against Russia.
The European economy will certainly move toward restoring strength across Europe, because the EU as a whole has been suffering. The early market reactions have gone in favor of avoiding panic in European financial markets at both the Paris Stock Exchange and other major financial capitals.
Of course, transportation, particularly airline and luxury good stocks, could be affected the most by the potential reduction of tourism due to fear following the recent terrorist events. However, the overall index performance was stirred but not shaken, as one fictional government agent (James Bond) might put it.
This was a very different reaction compared to what unfolded following the 9/11 attacks on New York City, when U.S. authorities decided not to open Wall Street. In fact, the stock exchanges in the U.S. remained closed until September 17, seeing an 11% loss by September 21.
Could Terrorism Hit the Euro to Dollar Forecast for 2016?
The attacks in France occurred while the markets were closed, at the start of the weekend, giving investors at least 48 hours to digest the news and contemplate whether the economy would be affected, let alone the EUR to USD exchange rate. In contrast, the 9/11 attacks on the World Trade Center took place at the start of an ordinary business morning, when markets around the world (apart from Wall Street, which was just about to open but remained closed, in shock) were already open.
Meanwhile, the seven coordinated terrorist attacks in Paris on November 13 can feed off the risk appetite, or risk aversion, in the markets over the short-term, according to JPMorgan and Credit Suisse. The latter points out that this negative occurrence could spur the European Central Bank to announce a strengthening of the quantitative easing that was launched in March as early as December 3, when it meets next. Currently, the ECB’s QE program includes the purchase of securities on the open market for $64.5 billion per month until September 2016, at the earliest.
Now, the markets are expecting something more from the ECB: an extension of the amount printed monthly to purchase securities and a strong stimulus plan that may account for the European stock market indices trading at the same levels as before the November 13 attacks. Nevertheless, such attacks have often produced rallies only to be followed by proportionately greater selloffs. A month was all it took for the Jakarta Stock Exchange to burn through the 10% gains after bombs killed 200 people in Bali nightclubs.
Of course, there are also the contradictions that confirm the rule. After an initial bearish reaction, the Bolsa de Madrid, the Madrid stock exchange, rose after the bombings of three trains in the city that killed 192 people in 2004. Likewise, the London Stock Exchange was in steady recovery mode a week after the July 2005 bus and subway attacks.
Still, Draghi’s promise of further quantitative easing (QE2) is the factor that has most helped sustain the European stock indices, but will it work? How will QE2 alter the euro to dollar forecast? If it doesn’t work for the better, the European markets risk collapse.
For many years, monetary policy has been dominated by quantitative easing, but its beneficiary effects have actually been rather lame. Everywhere, inflation figures are lower than the wishes and expectations of central banks, which defies the theory driving the low-interest-rate policy in the first place. Moreover, low interest rates haven’t helped a single country stimulate a recovery worthy of the term.
The numbers speak loudly; with or without QE, according to OECD data, no advanced country has an inflation rate higher than two percent, that is, apart from Iceland.
Not so long ago, inflation was the enemy; now it is the desired symptom, demonstrating robust economic growth.