Hard Times for Euro to Dollar Exchange Rate
It’s become ridiculously easy to forecast the euro to dollar exchange rate. It’s not that I’m brilliant or anything; it’s just that central banks on both sides of the pond make it really obvious. They telegraph their intentions for the EUR to USD so transparently.
Both the European Central Bank (ECB) and the Federal Reserve have been perfectly clear about the preferred direction of their currencies. All we have to do is find the sum of their actions. So let’s break it down.
The Fed spent a bunch of years pumping money into the economy and pushing its interest rates toward zero. The Fed did that because it’s what central bankers are supposed to do in a recession. And it (somewhat) worked: unemployment fell and the stock market soared.
So they pulled back on the money printing back in 2014 and (finally!) raised interest rates by the end of 2015. Anyone who studied Econ 101 knows that’ll make the U.S. dollar appreciate in value. But the Fed didn’t want to turn markets upside down, so the rate hike was a measly 0.25%.
By contrast, the European Central Bank was just sitting on the sidelines. It wasn’t as active as the Fed after the financial collapse of 2008. The European economy is proof enough—it’s been growing so slowly that the ECB finally decided to use a tactic from the Fed’s playbook. The ECB started printing euros last year. (Source: “ECB Faces Difficult Balancing Act to Revive Eurozone Inflation,” The Wall Street Journal, March 8, 2016.)
The ECB has been pouring 66 billion euros a month into the money supply. Once again, anyone who’s taken Econ 101 knows the goal here is to devalue the euro. That’s what money printing is supposed to do. It makes a country’s exports more attractive by depreciating the currency.
So on one hand, we have the ECB printing more cash. And on the other hand, we have the Fed raising interest rates…hmmm I wonder why the EUR to USD has been falling? To borrow a phrase, “It’s the economy, stupid!”
Unfortunately, these trends are only going to continue. The ECB is ramping up its asset purchases this week and the Fed is likely going to raise rates again this year. (Source: “U.S. hiring surges, bolsters Fed rate hike prospects,” The Globe and Mail, March 4, 2016.) With continued pressure from both central banks, I expect to see parity in the euro to dollar before 2016 is done.