EUR/USD Exchange Rate Could Crash in 2016
The euro to dollar exchange rate has fallen quite a bit this year. On January 1, 2015, the EUR/USD exchange rate was at 1.2103. Today, the pair is trading at 1.0640. That’s a massive depreciation for the euro against the mighty greenback!
Going forward, the situation does not look cheerful for the EUR-USD rate. The divergent paths between the eurozone economy and the U.S. economy, combined with the two central banks’ dramatically different monetary policies could bring further depreciation for the euro to dollar exchange rate.
Here’s the Problem for the Euro
The European Central Bank (ECB) is quite clear about its stance on monetary policy. In a recent meeting in Frankfurt, ECB president Mario Draghi said explicitly, “We will do what we must to raise inflation as quickly as possible. That is what our price stability mandate requires of us.” (Source: “ECB President Mario Draghi Hints at QE Action in December Meeting, Sending Euro Diving,” International Business Times, November 20, 2015.)
When it comes to price levels, the ECB has an inflation target of two percent. In reality, the eurozone’s consumer price index edged up merely 0.1% in October, still a long way to go to reach the target. To make matters worse, such a low inflation number brings worries to the real economy. If deflationary pressure builds up, households and businesses might want to hold back on their spending in the hope that prices will drop in the future.
Mind you, the ECB is already doing quite a bit, buying $63.1 billion worth of bonds every month. The ECB started the massive $1.16-billion quantitative easing program back in March of this year. In September, it raised the purchase limit of any given bond from 25% to 33%. Also note that during the recent meeting, Mario Draghi said that all monetary instruments are on the table, meaning the ECB could make another rate cut, if needed.
Compared to the ECB, the U.S. Federal Reserve’s tone on monetary policy couldn’t be more different. The Fed is expected to raise interest rates for the first time since the Great Recession during the next Federal Open Market Committee (FOMC) meeting on December 15–16. How likely is the rate hike? Well, according to Pacific Investment Management Co., the probability that the Fed will raise interest rates in December sits at 74%. (Source: “Fed Rate-Increase Odds at 74% in Market as Pimco Sees Liftoff,” Bloomberg, November 23, 2015.)
Euro to Dollar: Economies Heading in Different Directions
Another bearish argument on the euro is that the eurozone economy simply cannot compete with the U.S. when it comes to growth. In the third quarter of 2015, gross domestic product (GDP) in the eurozone grew a mere 0.3%, even weaker than the 0.4% expansion seen in the second quarter.
Meanwhile, the U.S. has been enjoying much faster economic growth. U.S. GDP advanced at an annual rate of 2.1% in the third quarter of 2015, up from the initial estimate of 1.5% growth. In the second quarter, GDP growth was an even more impressive 3.9%. (Source: “News Release—Gross Domestic Product,” Bureau of Economic Analysis, November 24, 2015.)
Bottom Line on the Euro to Dollar Exchange Rate
So, what do we have? An economy that is growing rapidly with tight monetary policy on the way and an economy where growth is lackluster and the central bank is printing massive amounts of money. The eurozone’s problem won’t solve itself that quickly and the euro-dollar exchange rate is looking bearish going into 2016.
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