Why the Euro Dropped More that 7.5%
As I’ve previously written, there are certain underlying trends that can give us a clear direction for the euro to dollar exchange rate. The EUR to USD has already taken a beating in recent months. Here’s why that pattern could continue for the euro to dollar outlook in 2016.
For one thing, there’s the refugee crisis unfolding across Europe. The problem has been brewing since Syria fell into chaos and civil war, but the refugee crisis only went mainstream in 2015. Countries like Germany began accepting those who sought a new life away from the violence that is engulfing much of the Middle East.
The transition hasn’t happened smoothly, nor is it likely to resolve quickly. Europe is clearly on the brink of a major political confrontation over the question of refugees, but that is the subject of another article. We’re concerned with the potential impact it could have on the euro to dollar exchange rate.
At the same time, there was a surprising amount of positive news in the U.S. during the last half of 2015. From the passing of a federal budget to rising interest rates, the American economy has actually moved forward in a way that Europe has not.
Politics Has a Ceiling
Politics is about priorities. If your issue isn’t near the top of the list, chances are it won’t get very far. That’s a fairly universal principle, because all governments are constrained by the wheeling and dealing of multiple players that have distinct agendas.
There isn’t a physical list anywhere, but you can approximate an issue’s importance by how much time it gets on news programs or how many articles are written about it.
After the 2008 financial crisis, economic issues climbed up the list. Particularly in the United States, mainstream headlines were dominated by arcane subjects like monetary policy or budget cuts. When the European sovereign debt crisis arrived two years later, Europe, too, became obsessed with financial stability.
And those were good things. The attention placed on those issues forced action, but after the Greek debacle this past summer, all eyes turned to the refugee crisis. And it doesn’t matter what your opinion on the refugee crisis may be, the attention alone elevates it above more important economic issues. (Source: “Germany’s right-wing AfD party surges to new high amid concern over refugees,” Independent, January 13, 2016.)
As European lawmakers squabble about the minor sums it takes to house and re-establish normal lives for refugees, hard questions about the euro’s long-term stability go unanswered. What will happen when Greece’s current round of funding expires? Can the country sustain itself or will the sovereign debt crisis rear its ugly head once more?
There are tens of billions on the line in Europe’s financial markets and all of them are getting less attention than the refugee crisis. I am not seeking to minimize the humanitarian crisis in progress; I am saying the backlash over letting refugees into Germany is borne from people’s economic uncertainty.
Why the EUR to USD Could Fall Further
However, I am a realist. The refugee crisis will likely dominate Europe’s political discourse for 2016 and economic issues will probably get pushed to the background.
Without substantial action from nation states, the entire fate of the euro falls on the shoulders of Mario Draghi at the European Central Bank (ECB). When the ECB cut rates by only 10 basis points last month, investors were sorely disappointed. (Source: “ECB policymakers pushed for more stimulus ahead of December vote,” Financial Times, January 14, 2016.)
Take that in for a moment. Cutting interest rates lowers the value of a currency, and investors were upset that Draghi only cut interest rates by 10 basis points. Since it’s unlikely that Europe’s flailing economy will be saved by its national governments, ECB Chairman Mario Draghi may have to oblige markets by further slashing interest rates.
That means the EUR to USD exchange rate is all but guaranteed to drop further. Considering that the euro has dropped by almost eight percent in the last year, it would be reasonable to expect the euro to dollar outlook in 2016 to reach parity.