EUR/USD: This Could Ignite a Collapse in the Euro to Dollar Exchange Rate

EUR USD: This Could Ignite a Collapse in the Euro to Dollar Exchange RateThe eurozone will see greater challenges in 2016, forcing the euro to dollar outlook lower, especially if the European Central Bank (ECB) remains satisfied with its current monetary policy. However, it will need to extend its expansion plan to purchase bonds again in September 2016.

This is because it is unlikely that growth or inflation will rise in the eurozone sufficiently to warrant a shift. The ECB may need to expand quantitative easing (QE) in 2016 as a result. Indeed, the ECB’s decision to provide more stimulus in December showed a sense of urgency and a general concern for the economy. This, no doubt, helped boost the U.S. dollar, higher Fed interest rates notwithstanding.

In 2015, the ECB did see some positive results, as Germany showed signs of a recovery. Other important risks remain lurking around the corner for the eurozone, however, pushing the euro lower and threatening U.S. dollar-euro parity.

The prospect of greater weakness in emerging markets, particularly in China—which will keep commodities and major producers, like Brazil, under pressure—will combine with rising unstable geopolitical situations in the Middle East and Russia. High unemployment and stagnant wages are just the beginning of the issues that foreshadow further downside risk for the eurozone in 2016.

The Biggest Risks for the Eurozone in 2016

Greece may well resume dominating the front pages, while the Tsipras government strives to implement reforms and meet the demands of the country’s bailout. Greece has not yet washed away the risk of default.

More significantly, the migrant and refugee crises that exacerbated in the last months of 2015 will intensify amid ever-worsening tensions, putting additional pressure on the euro in 2016. In 2015, European nations agreed to receive millions of Syrian refugees, but terror attacks in Paris on November 13 have hardened Europeans’ attitudes and hearts. Most European citizens and some governments, the latest being Sweden, have been calling for tighter border controls.

Migration flows will intensify quickly if the so-called Islamic State or similar groups conduct more attacks in other countries, while tensions between Russia and Ukraine have shattered the illusion that conflicts in Europe are a thing of the distant past. The European Union (EU) has reluctantly adopted sanctions that have both jeopardized the member states’ economies as well as diplomatic relations with Russia. By the spring of 2016, the EU will have to choose whether to continue with its “shooting itself in the foot” sanctions policy toward Russia or remove them. (Source: “Russian lawmaker: EU will try to review sanctions against Russia in spring,” TASS, December 23, 2015.)

This debate will be all the more relevant because the prospect of even higher interest rates in the United States and the continuation of stimulus from the ECB will keep the euro under pressure. The one redeeming factor for the euro—and more directly for eurozone economies—is that as the currency nears parity, for example touching US$1.05, exporting countries like Germany, France, and Italy should benefit significantly from the combination of the ECB’s QE and the lower euro.

If the economy really improves—which isn’t likely, but as Lloyd Christmas says in the classic movie Dumb and Dumber, even with one-in-a-million odds, there’s still a chance—the ECB will get all optimistic and in its exuberance, it could lower stimulus, signaling a turning point for the euro and reversing the current EUR/USD trend. However, this would require bundles of the kind of sanguine sentiment that is in short supply in Brussels and Frankfurt these days.

As for migration issues, the present wave of refugees seeking asylum in Europe is the largest refugee crisis to affect Europe since World War II. It is not going anywhere in a hurry. Among the many cries for help and offers of solidarity and generosity, the EU has not even begun to understand the costs and extent of the humanitarian crisis.

In the months and years ahead, each EU member state will have to confront its own respective economic consequences of the EU’s foreign policy and the resulting crisis. Continuing austerity policies, aimed at sustaining the euro, have triggered social, economic, and political discontent, all accented by problems in Ukraine and the rising Brexit sentiment, which could put the U.K. outside the EU.

Even if the EU has not revealed the full cost of economic losses due to the trade war with Russia, according to Spanish Foreign Minister Jose Manuel Garcia Margalo, because of the sanctions, the EU lost about 21 billion euros. (Source: “EU Lost 21 Billion Euros Over Anti-Russian Sanctions – Spanish FM,” World Affairs, September 2, 2015.)

The Austrian Institute for Economic Research (WIFO) has assessed the macroeconomic effects of losing trade to 34 billion euros in the short-term and 92 billion euros in the long run. (Source: “Disrupted Trade Relations Between the EU and Russia: The Potential Economic Consequences for the EU and Switzerland,” WIFO, July 3, 2015.)

At the same time, there are no actual numbers of just how many refugees are reaching the European Union, or does anybody really know the actual cost of this invasion. Nevertheless, last November, the Organisation for Economic Co-Operation and Development (OECD) issued a report about the possible economic impact of the refugee crisis in Europe.

Europe Is Being Overrun with Asylum Seekers

The expenses in the short-term to provide assistance to asylum seekers are significant. Then there are the costs of humanitarian assistance to provide food and shelter, expenses associated with the necessary linguistic training and schooling, steps to identify the skills of immigrants and the costs associated with the processing of asylum applications, and more. All of this is expensive when you consider the refugees and migrants number in the millions, not the thousands.

The allowance paid to migrants varies considerably from country to country and can range from about 10 euros per day for single adults accommodated in reception centers to 300 euros for those without housing. Typically, the total cost for accommodation of asylum seekers varies between 8,000 and 12,000 euros in the first year. (Source: “Germany: Migration Crisis Becomes Public Health Crisis,” Gatestone Institute, November 12, 2015.)

The direct fiscal impact of the reception of refugees will be high in the short-term. However, promises that it will decrease rapidly over time as they are integrated into the labor market are overly upbeat. The crises in the countries of origin of the refugees and migrants, namely Syria but also Iraq and Libya, are not showing any signs of mitigating. Instead, they are increasing.

Pierre Gramegna, finance minister of Luxembourg, has asked the European Commission to do an analysis for the total financial impact of the refugees. Some member states have asked for EU budgetary constraints to be withdrawn in order to address the financial burden of refugees. Ireland, Austria, and Italy have expressed such concerns. Irish Secretary for Finance Simon Harris estimated that the cost to his country would be in the tens of millions. (Source: “EU to weigh economic costs of refugee crisis,” Yahoo! News, September 11, 2015.)

Even Germany, which announced a cost estimate for the refugees and their integration into German society, has seen growing objection from the right-wing parties, which estimate costs to hover between 1.8 billion and 3.3 billion euros in 2016 to take care of refugees from Syria and Iraq alone.

That’s why the theme of assistance to refugees is shaking the EU. Europeans want to know how much it will cost and for how long, as they continue to endure the snowballing cost of bad policies that the refugee crisis has served to expose.

The Bottom Line on the Euro

Where the EU is concerned, apart from any additional military burdens in the region, the flow of potential refugees could far outpace and outnumber current estimates. Apart from the inevitable costs, EU citizens might become more reluctant toward the refugee intake policies, weakening political links like the Schengen passport-free zones. In other words, the Middle East refugee crisis risks breaking important layers of the EU, even as it generates expenditure costs that its citizens are reluctant to endure.

All this will put enormous pressure on the euro to dollar exchange rate in 2016.