Euro to Dollar Collapse Imminent?
The euro to dollar exchange rate is headed in such an obvious direction that writing about it is almost a chore. The EUR/USD pair took a hit this week, as investors braced themselves for the Federal Reserve meeting, which is currently in progress.
It’s now almost certain the Fed will raise interest rates. There’s barely any mystery left about it, with both investors and economists in agreement that we’ve reached the tipping point. Put it this way: if the Fed doesn’t hike up the federal funds rate, there could be wild currency swings, a pullback in stocks, and an overall loss of faith.
Trust is the coin with which central bankers do their job. After all, monetary policy can only work to improve the economy when investors believe what the central bank has to say. Otherwise, they cannot form an informed portrait of the future.
Right now, the expectation in all quarters is a rate hike. It won’t be much; probably just 0.25%, but the increase should be enough to snap the euro to dollar exchange rate. In fact, I think we’ll see the EUR/USD reach parity before 2016 is over.
Janet Yellen Is Committed to a Stronger Dollar
There were two basic conditions the Federal Reserve governors laid out for a rate hike: unemployment levels and core inflation.
The inflation part makes sense, because it’s an explicit part of the Fed’s mandate, but tying the period of low interest rates to unemployment levels was unexpected. No one thought that keeping Americans employed was even remotely within the sphere of the Fed’s jurisdiction, but the Fed rationalized it in a really convincing way.
First off, it pointed that Congress wasn’t doing anything to help the economy with its loud, partisan squabbles and fights over the debt ceiling. With that level of complacency, argued the Fed, it fell on the central bank to revive the American economy.
And so it did. Then-chairman Ben Bernanke said the central bank would start pulling back its monetary stimulus when the unemployment rate fell to 6.5%. It was 7.7% at the time he said that, but it’s fallen way below the Fed’s target. The Bureau of Labor Statistics says the unemployment rate is now five percent. (Source: “Federal Reserve pledges low interest rate until jobless level eases to 6.5%,” The Globe & Mail, December 12, 2012.)
So why didn’t the Fed stick to its word? Well, the reason lies in the Fed’s main commitment: price stability.
The Euro to Dollar Outlook for 2016
Despite all the people talking about inflation and hyperinflation, the U.S. economy has actually struggled with the opposite. Inflation has been near zero for a long time, forcing the Fed to delay its plans. Then a few days ago, data emerged showing a two-percent inflation rate for the 12 months preceding November.
Two percent is quite literally the Fed’s ideal number for inflation. With both boxes on its list checked off, there is virtually no chance Janet Yellen will postpone a rate hike. As a result, we’re going to see the U.S. dollar soar against the euro, a positioning that could damage the purchasing power of European importers.
It’s been seven years since the last time interest rates were further away from zero than they are today. On a personal level, I’ll be tilting my exposure from the euro to dollar exchange rate, but my window of opportunity is small. The magnitude of what’s about to happen can’t be overestimated.