The euro fell against the dollar as a result of various factors – 06/07/2022 at 17:01

The euro fell against the dollar as a result of several factors

In general, the euro has lost its advantage against the dollar since the last major economic crisis in 2008 when the latter approached 1.6 dollars for 1 euro. Since the health crisis and more specifically since January 2021, the euro has started to fall sharply and recently fell close to parity with the dollar. Thus, the lack of confidence in the European currency is causing investors to switch to the US currency. But for what reasons?

From a structural point of view

The two currencies, the euro and the dollar, are closely related due to their history, their respective economies, and their geopolitical status. Each stems from two large, powerful and influential regions, yet the dollar has distinguished itself for decades as the remaining master of the exchanges. Indeed, during the third quarter of 2018, according to Orobel, the dollar represented about 62% of all known foreign exchange reserves of central banks. About 580 billion dollars in banknotes are used outside the country. Another telling number, 40% of the world’s debt is denominated in dollars. American hegemony at the monetary and, consequently, financial level has been proven. It allows the United States to encourage many countries to follow its policy and that of the Federal Reserve.

When successive crises hit, the dollar emerged as a safe haven at the expense of the euro. Thus, the euro reached critical levels three times, that is, close to parity with the dollar. These periods can be observed in 2003 at its creation, in December 2016 / January 2017 and today. During these episodes one can notice that the euro is being exchanged for $1.05. Therefore, it is unusual to see the euro weigh so little against the dollar. The reasons are many.

First of all, remember that the US economy is doing much better than the Eurozone. In 2021, US GDP rose 5.7%, its best performance in 37 years, versus 5.2% for the European Union. The world’s largest corporations are located in the United States, international finance is still largely dominated by Uncle Sam’s country, and with the dollar, although its influence wanes, the Fed is flying and shining in global currency markets. Thus, between 62 and 65% of the world’s foreign exchange reserves are in dollars versus only 20% in the euro – a historical phenomenon as well, especially for energy. In terms of transactions, more than half are made in dollars. This first point gives the US dollar a definite advantage.

When the health crisis hit the world, the US economy has generally held up much better. Ouest-France wrote: “Bloomberg News recently published the latest edition of its ranking of countries most resilient to the Covid-19 pandemic. These are the countries best able to contain the health crisis while limiting disruption to economic and social life.” Uncle Sam’s country finds itself at number one and only three European countries in the top ten. In addition, the US unemployment rate is currently lower than in Europe, although it reached 15% during the crisis, compared to 8% for the euro. region. So the market dynamics are in favor of the US and therefore the dollar.

Finally, central banks in both economic regions do not react the same way to accelerating inflation. On the one hand, despite the high inflation on the other side of the Atlantic caused by the massive economic recovery plan implemented by the government during the crisis, the Fed is taking concrete measures such as raising interest rates to counter it. On the other hand, the ECB remains unaffected without actually making any decisions. However, Ms Christine Lagarde recently raised the possibility of raising key interest rates by the end of the year if inflation remains at current levels. So not every central bank’s credibility is seen in the same way, and that could lead to a lot of people turning to dollars.

From an economic point of view

We consider the equilibrium level between the euro and the dollar to be around $1.10 per 1 euro. Beyond that it becomes dangerous and could have consequences for the local economy. With the health crisis closely followed by a geopolitical crisis, the euro has crossed that threshold. Indeed, Russia’s declaration of war on Ukraine and its invasion in the process have highlighted a fragile Europe on many points. First of all and of course, from a military point of view, Europe may be unwilling to conduct and engage in a military conflict over time. Its military arsenal is relatively (relatively) weak and distributed means very low. Thus, its credibility on the international scene with regard to the current conflict in Ukraine can be called into question.

On March 15, at RFI, Christian Cambon, chair of the Senate Foreign Affairs and Defense Committee, made a disturbing revelation. According to Senator LR, France lacks “thickness” in terms of ammunition, and therefore cannot “withstand a prolonged conflict”. According to him, the stock will last at best “two weeks”. “I’m not imposing the line,” he says in conclusion, “in fact, I think the information you gave is still optimistic compared to reality, and unfortunately I’m considering specialized or conventional ammunition.”

Then Europe depends on gas and, to a lesser extent, on Russian oil.

The euro fell against the dollar as a result of several factors.  Source: Le Monde March 11, 2022

The euro fell against the dollar as a result of several factors. Source: Le Monde March 11, 2022

The possibility of Russia turning off the tap, though unlikely, would pose serious problems. The possibility of seeing Europe switch to other sources of energy, for example, is a possibility. The needs are enormous and the resources elsewhere, it takes time to prepare the contracts and infrastructure (such as LNG terminals) to be implemented: see the 27 agreement to reduce Russian oil imports by 90% by the end of the year. An economic area where resources can cause problems at the expense of their currency, even if the risk of a European shortage is not appropriate at the moment.

Finally, this conflict shows that Europe still depends on the United States on many points such as military protection. Specialists highlight the fact that NATO defends US interests as a priority.

What are the consequences?

This drop in the euro against the dollar has implications for the real economy. It results in both negative and positive effects. In the current monetary formation, it would provide Europe with support for its exports, increase the competitiveness of national products but also an attraction to foreign investors. According to Mark Touati: “Overall, a 10% decline in the euro equals 0.5 points of additional growth.” However, there are also negative effects such as increased imported inflation or the risk of rising bond prices.

Currently, the decline of the euro is one of the catalysts for the rise in inflation in the European Union. The increase in inflation lowers the purchasing power of consumers, an element at the heart of the news and worries citizens as well as governments of European countries. With the euro down, we expect to see an increase in public debt, which is already high and some see critical. This leads to higher long-term interest rates and thus limit access to credit, which means limiting investment. This will have the opposite effect at a time when the economy needs capital to recover from the previous health crisis.

A significant devaluation of the currency could destabilize the Eurozone. Tensions can arise and some countries may withdraw into themselves, in a context where maintaining relations is very important, through coordinated actions. At the moment in this aspect, countries are interacting well and proposing joint solutions and sanctions. Recently, in the sixth sanctions package that partially and gradually bans the import of Russian oil. This coordination may be positive for the euro’s rally against the dollar, which seems more than necessary to avoid cascading events that could put the economy and stability of the Eurozone at risk.

In conclusion, the current situation works against the euro. This currency cannot, across the economies that use and represent it, show its importance and credibility, in the direction that the euro does not appear as a strong currency. The consequences could be very important for taxpayers’ wallets but also more broadly for the overall balance of the eurozone. The European Central Bank will have to show serious monetary plans in the coming weeks and months to lift the balance in favor of the euro and avoid the worst, which is the euro that is well below the dollar. The development of the Russian-Ukrainian conflict could significantly affect future decisions, hence the ECB was very cautious and slow in its decisions.



The euro fell against the dollar as a result of several factors

The euro fell against the dollar as a result of several factors

We can see very clearly that EURUSD prices have been trapped in a huge bearish LT channel since June 2008. The pair tested the upper boundary of the mentioned channel on several occasions between January and May without succeeding in getting rid of it. Also, as long as the new pivot point at 1.1 is not exceeded, we will have to be careful, and a recovery of the dollar will be possible first until parity of 1 against 1, before the dollar dominates towards 0.97. The scenario will be confirmed by a drop below 1.034 (under strong pressure). If necessary, we will have to wait for a pass above 1.1 to consider a recovery in the euro with 1.145 on the horizon.

Directed by Alex Delage Murox, with assistance from Mark Dagher

This article was originally published on DT Expert

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