With a war on the eurozone’s borders, uncertain energy supplies from Russia and a growing risk of recession, pressures on the euro eventually became so strong that on Wednesday it fell to parity with the US dollar – a one-to-one exchange rate. It is a sight not seen since December 2002, in the early years of the currency’s existence. The aesthetically pleasing round number has become a focal point for investors. In currency markets, “1.00 is probably the biggest psychological level,” analysts at Dutch bank ING said in a note to clients. Even more remarkable than breaking this level is how quickly the euro fell against the dollar. The currency, shared by 19 European countries, has fallen more than 11 percent this year as the dollar’s strength has been virtually unmatched. The euro’s sharp decline came as the dollar, one of the safest places to park money for generations, has strengthened against nearly every major currency in the world. Currencies move like stocks, bonds, or any other asset — investors can buy them directly when they think they will rise in value and sell when they think they will fall. They also reflect global demand for a country’s assets in general, because buying US Treasuries or Apple stock requires getting dollars first, and many global transactions are done in dollars. So, as often happens in times of economic distress, people looking for a safe place to put their money have bought more dollars, at the expense of other currencies such as the euro. The euro was introduced in 1999 after decades of discussion and planning, with the aim of bringing unity, prosperity and stability to the continent. After two major wars in the first half of the 20th century, the argument for the euro and the wider European enterprise was that common institutions would reduce the risk of war and crisis and provide diplomatic spaces for conflict resolution. The euro was a crucial symbol of this unity. But like all currencies, the euro is only as strong as people’s faith in it. This was sorely tested about a decade ago, when investors fled the debt of over-indebted nations and bailouts led to disputes over fiscal policy. The crisis threatened the currency’s future, but faith has mostly been restored. The eurozone, which started with 11 countries, will welcome its 20th member next year. In recent months, however, a huge number of factors have been rallying against the euro and in favor of the US dollar, which has rebounded as a safe haven during economic turmoil.
8 signs the economy is losing steam
Card 1 of 9 An alarming prospect. Amid persistently high inflation, rising consumer prices and falling spending, the US economy is showing clear signs of slowing, fueling fears of a potential recession. Here are eight more measures that signal trouble ahead: Consumer confidence. In June, the University of Michigan survey of consumer sentiment hit its lowest level in its 70-year history, with nearly half of respondents saying inflation is eroding their standard of living. The housing market. Demand for real estate has fallen and construction of new homes is slowing. Those trends could continue as interest rates rise and real estate companies, including Compass and Redfin, have laid off employees in anticipation of a downturn in the housing market. Copper. A commodity seen by analysts as a gauge of sentiment about the global economy – because of its widespread use in buildings, cars and other products – copper has fallen more than 20% since January, hitting a 17-month low on July 1. Oil. Crude prices have rallied this year, partly due to supply constraints stemming from Russia’s invasion of Ukraine, but have recently begun to wobble as investors worry about growth. The bond market. Long-term government bond yields have fallen below short-term yields, an unusual event traders call a yield curve inversion. It suggests that bond investors are expecting an economic slowdown. Globally, supply chains have been disrupted by the pandemic and the war in Ukraine. Since Russia’s invasion in February, prices of essential goods including oil, natural gas, wheat and fertilizer have soared, pushing up food and energy prices around the world. This has led to the highest inflation rates in decades. Now central bankers in the United States and Europe have pledged to reduce inflation through higher interest rates, even as the global economic outlook worsens. The risk of a recession has been exacerbated by restrictions on Chinese production due to Covid-19 rules, while efforts to wean Europe off Russian energy are proving difficult to achieve. These trends have made the dollar stronger while not doing much to help the euro. “The outlook remains very supportive for the dollar,” said Ebrahim Rahbari, global head of foreign exchange analysis at Citi. The fall in the euro has fueled concerns that the eurozone will fall into recession. Last week, uncertainty over the future of Europe’s energy supplies and growing concerns that Russia will permanently shut down a critical natural gas pipeline to Germany pushed the euro to its lowest level in 20 years. But bets on the rate started piling up months ago. Since April, Jordan Rochester, a strategist at Japanese bank Nomura, has been betting that the euro will reach parity with the dollar. Similar predictions followed, including from JPMorgan Chase and HSBC. Then came a brief respite in the fall of the euro. Among other things, European Central Bank President Christine Lagarde presented a clear plan to raise interest rates for the first time in more than a decade in July and signaled an early end to the eight-year era of negative interest rates. fall. Since then, policymakers have stepped up their commitment, saying that when rates rise again in September, the jump will likely be even bigger than in July. In the end, it wasn’t enough to change the currency’s trajectory. “It’s hard to find much positive to say” about the euro, HSBC analysts wrote in a note to clients in early July. “Economic news is very challenging.” Around the same time, Nomura’s Mr Rochester said he expected the euro to reach parity with the dollar by the end of August. In the end, it happened much faster. “It’s very much human psychology,” Mr. Rochester said. There is no market-based reason that the rate is important — “it’s just a round number,” he added. But it could mark the beginning of a period similar to the currency’s early years, when trades ranged from 82 euro cents to 1 euro to the dollar.
Understand inflation and how it affects you
Back then, in the early 2000s, before the euro existed in the form of banknotes and coins and was just a virtual currency, the low exchange rate undermined confidence in the new currency. The European Central Bank even stepped in to try to shore it up. Today, there are fewer questions about the durability of the euro as progress has been made in consolidating the union. The central bank’s pledge to preserve the currency a decade ago has not been significantly tested since then. But the weaker currency creates an additional headache for the European Central Bank because it will add to the region’s inflationary pressures by raising the cost of imports. Central bankers say they are not targeting an exchange rate level, but it will be difficult for them to contain the currency’s fall in words because the forces pushing the dollar higher have been so strong. With inflation in the United States near its highest rate in four decades, the Federal Reserve has stepped up its monetary policy tightening with big interest rate hikes. Jerome H. Powell, chairman of the Fed, said at a conference in late June that he expects the benchmark interest rate to go as high as 3.5% this year. He added that there was a risk that the central bank would go too far in raising interest rates to cool the US economy, but that letting inflation remain high was a bigger risk. As Mr Powell spoke, he sat next to Ms Lagarde at the European Central Bank’s annual retreat in Sintra, Portugal. While she agreed with him on the risk of persistent inflation, it did not match his commitment and clarity on how high interest rates could be raised in the eurozone. Investors can only speculate about what might happen by the end of the year. But even ahead of the first rate hike on July 21, the growing risk of a recession in the euro zone has investors wondering how high the bank can raise rates before it has to stop again. “The ECB will struggle to match the Fed’s determination to tackle inflation or raise interest rates,” said Mr Rahbari, an analyst at Citi. While the European Central Bank plans its interest rate hikes, it must also monitor government bond markets. There have been concerns about the impact of rising interest rates and the end of the central bank’s bond-buying programs on the bloc’s most indebted members. In Italy, for example, borrowing costs rose sharply in June, and officials are trying to discern how much of those moves fairly reflect the riskiness of Italy’s economic situation and what was so-called fragmentation, or rapidly diverging interest rates across the eurozone, less effective. The bank is preparing a new policy tool to address this fragmentation, which central bankers see as a disconnect between economic fundamentals and the government’s borrowing costs. “It will be another testing period for the eurozone” and its central bank in the coming year, Mr Rahbari said.
