Bail on the Euro to Dollar Exchange Rate
Whereas the European Central Bank’s (ECB) continued monetary easing was not enough to make a major dent in the EUR/USD exchange rate, Tuesday’s bombings in Brussels might. The euro to dollar exchange rate is now US$1.12, edging ever closer to parity. The latest geopolitical and economic indicators suggest EUR/USD at US$1.00 is coming. Growing rumors of the Fed preparing two more rate hikes in 2016 have all but made parity a certainty.
On Tuesday, the euro was dropping because of terrorism. On Wednesday, the euro continued dropping because of the more hawkish members of the Fed. In fact, while Europe keeps being distracted by migration problems and increasing terrorism fears, economic sentiment in the United States is bullish, as shown by the latest data from the Fed published last week. The reaction to the attacks in Brussels shows that the euro has lost its appeal as a safe haven.
The attacks coincided with the president of the Federal Reserve Bank of Atlanta, Dennis Lockhart, hinting that the Fed may raise interest rates in April. (Source: “Fed’s Dennis Lockhart: Economy Could Justify Rate Increase as Soon as April Meeting,” The Wall Street Journal, March 21, 2016.)
The president of the Philadelphia Fed, Patrick Harker, echoed Lockhart’s suggestion. Harker added that if the economy were to continue to grow at the current pace, the Federal Reserve should consider another increase in interest rates as early as April. He would even welcome at least three more increases later this year. (Source: “Philadelphia Fed Chief Harker Calls for 3 Rate Hikes This Year,” Reuters, March 23, 2016.)
Meanwhile, Lockhart and Harker’s suggestions aren’t just more hot air; the Fed still plans to increase the rate twice in the course of 2016. So, it is just a matter of time.
Even the president of the Chicago Fed, Charles Evans, expects two more rate increases during 2016, unless the economic data do not prove to be much better than expected. (Source: “As Fed eyes two rate hikes, dovish Evans is no longer fringe,” Reuters, March 22, 2016.)
The report on new home sales, expected during the day, should show an increase of 510,000 units compared to 494,000 in January, a 3.2% increase in January. The higher home sales data are going to add more lift on the dollar and pressure on the euro. New U.S. single-family home sales rebounded modestly in February pointing to an improving housing sector. (Source: “U.S. new home sales rise on strong gains in the West,” Reuters, March 23, 2016.)
In turn, it is unlikely that European growth or inflation will reach a high enough level to match the United States, thereby prompting a shift in the current quantitative easing trend favored by the European Central Bank (ECB). Euro to dollar exchange rate parity is a realistic expectation. Indeed, while the ECB will stimulate the flow of money, the U.S. Federal Reserve could increase rates again.
The prospect of more 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 the spillover effects with refugees and terrorists putting pressure on the seams.
There is still the issue of Russia and the cost that sanctions have had in several European countries. Sanctions and Russia’s inevitable reactions have broken what was a lucrative market in a rapidly expanding consumer economy. Amid all that, high unemployment and stagnant wages remain.
Amid the variety of sources putting pressure on the eurozone’s economy, the U.S. shows comparably much stronger results. The U.S. labor market created 242,000 jobs in February according to the U.S. Department of Labor. Meanwhile, the unemployment rate remained at 4.9%, its lowest level in eight years. This may persuade the Fed to raise interest rates.
The ECB has little choice. It will act more aggressively to achieve a two-percent inflation target. ECB governor Mario Draghi will do so even if it means intensifying the scope of the quantitative easing (QE) he already eased in 2015.
Time to get bearish on the euro to dollar exchange rate.