Most Important Number for the EUR to USD Rate
If you think the decline in the EUR to USD is over and the currency pair has stabilized, you should pause and reflect on the facts. Problems in the euro area suggest parity could be possible for the EUR to USD exchange rate in 2016.
First of all, economic conditions in the eurozone are outright gruesome. Know that it’s not only the debt-infested nations like Greece, Spain, Portugal, and Italy that are struggling; we are seeing data points that suggest the bigger nations like Germany and France are starting to face headwinds, too.
Slow economic growth or an outright economic slowdown in the eurozone is not good for currencies and its impact will definitely be reflected in the direction in which the EUR to USD exchange rate goes.
But if you think slow economic growth isn’t enough, know that the governments in the eurozone countries are unable to come up with fiscal policies to boost their economies.
You must understand: an economy can only go forward when monetary and fiscal policies are aligned.
Mind you, the head of the European Central Bank (ECB), Mario Draghi, recently warned about this. He said, “If other policies are not aligned with monetary policy, inflation risks returning to our objective at a slower pace.” In simple words, he is saying that if government policies don’t change, it could be a very long time before there’s economic growth in the eurozone. (Source: “Mario Draghi Urges Governments to Help ECB Hit Its Inflation Target,” The Wall Street Journal, June 9, 2016.)
Lastly, understand the interest rate difference. The ECB is implementing a negative interest rates policy (NIRP), while the U.S. still has positive interest rates.
Thanks to these positive interest rates, U.S. debt is still positive. Look at the chart of yields on the five-year U.S. Treasury.
Chart courtesy of www.StockCharts.com
Yields on the five-year U.S. Treasury currently stand at 1.21%. In Germany, the biggest economic powerhouse in the eurozone, the yield on five-year Bunds is -0.43%! This means that you lose money by investing in bonds.
With this, I ask one question: where would you rather invest your money—a place where you earn a positive return or a place where you are guaranteed to lose money?
If those were the only choices, buying where you get positive returns is a no-brainer. This could be the thinking of a lot of investors in Europe. If we assume they want to buy U.S. debt, they will have to turn their euros into U.S. dollars. This creates demand for the greenback and hurts the value of the euro.
With all this said, one must really question where the euro to dollar exchange rate is headed.
No matter how you look at it, the EUR to USD pair could see further downside ahead. Mind you, parity isn’t far from where the currency pair currently trades. It’s just roughly 12.2% below.
Could the exchange rate really reach parity? In 2015, the euro to dollar exchange rate moved down roughly 9.5%. In 2014, it dropped approximately 10.5%. My point? Yes, it could happen. The EUR to USD pair has been volatile over the past seven years, so don’t rule out more volatility ahead.
EUR to USD bulls beware!