Euro-Dollar Parity is Back

While the global markets absorb the potential of high U.S. interest rates, the EUR/USD currency pair tanked to levels of $1.0366 overnight, testing 14-year lows. (For more, see Fed Projections: Where Do Rates Go From Here?)

Since the global financial crisis of 2008, when euro hit record high of $1.604, the single currency has been sledding downhill against the dollar. The euro has lost more than 7.5% since October alone. The recent declines have not been unexpected, as the interest rate differential between the U.S. and Europe has widened out significantly. The Fed’s rate hike only built on last week’s European Central Bank’s (ECB) decision to extend the Quantitative Easing (QE) till next year end, and paved the way for further decline in forex rate.

Despite the temporary support gained by the euro in early December, when Italy voted against constitutional reform, the recent breach of major technical support levels could lead to parity, i.e. euro trading one-for-one against the dollar. Perennial query remains on the financial impact, what’s next, and for how long.

The long-prevailing weak economic prospects in Europe have compelled the ECB to opt for a weaker euro, which would make European products cheaper and help bump up European exports. The Fed’s decision amplified the ECB – and reflected positively on European markets, which gained around 1% on Thursday in the wake of the FOMC hike. (For more, see How Interest Rates Affect The Stock Market?)

However, with reduced purchasing power the European consumers will pay a higher price for dollar-denominated products, including key commodities like crude oil. A stronger dollar will also impact payoffs of dollar-denominated loans, which may cripple the financial systems not just in Europe but also in large developing economies. Along with global businesses, the higher dollar will diminish profit margins of American businesses which have overseas presence.

With President-Elect Donald Trump driving business-friendly policies in the U.S. amid Fed rate hikes, the greenback is expected to rise by another 5% to 10% in the near term, according to Win Thin, global head of emerging markets strategy at Brown Brothers Harriman.

Parity is a key psychological level last observed in early 2003, and may be difficult to sustain for long from a technical trading perspective. Technical analyst continue to maintain that EUR/USD 1.050 to 1.030 will be the key support levels over the next few weeks.

The natural balancing behaviors of economic developments are expected to support the euro. For instance, the spread of government stimulus like QE will trigger an increase in fiscal spending, which should bolster euro valuations in over the near term. Societe Generale believes the euro will face a temporary decline and hit parity in the first quarter of 2017, then bounce to 1.09 by the end of 2017. The latest 2017 market outlook from UBS forecasts the euro as high as 1.200 by the end of next year. A Reuters poll reports only 10 of more than 50 economists predicting a decline below parity.