Will EUR-USD Reach Parity This Year?

Yesterday the Euro fell to a one-year low against the U.S. dollar amid panic selling brought on by the crisis in Greece. It was a bloodbath for the market on the whole, as investors are fearing bleed-through to Portugal, Ireland, Spain, Italy, the UK, and a host of other potential victims. The closing rate of the Euro - USD was 1.2971, and Credit Suisse is predicting the Euro could drop into the 1.20-1.25 range.

My question for the currency traders on the site is what are the chances the dollar trades at parity to the Euro by year end? Or how about by this time next year? It could shape up to be a pretty epic trade, and it doesn't look like things are going to improve in Europe any time soon. Conversely, inflation on the US side will no doubt start taking a visible toll on the dollar in the same time frame. (I know it already has, but I'm not convinced the worst is over).

So what are the chances for parity between the currencies, and what is the best way for an average investor (non-Forex, obviously) to take advantage of the move?

 

I would say the chances are increasing but still small. I really expect Germany to leave the Euro if Spain and Italy decide they need aid. If Germany leaves then forget parity, the experiment is over. In regards to that, can anyone with more experience tell me what will happen if the EUR is left and countries go back to national currencies? Will those on the short end of the trade profit down to the last pip or will there be some fixed exchange?

And keep your eyes and France and their private sector exposure, they are staying quiet for a reason.

Best way to get exposed without trading FX: shorting financials and insurance companies, particularly Deutsche Bank (which I am not doing myself so consider yourself warned)

 
Edmundo Braverman:
France could easily return to the franc. The old franc infrastructure is still in place (down to items still being priced in francs today at the stores). I think the French were suspicious of the Euro from the get go.

Thanks for the topic, very interesting.

I am not a FX trader (senior associate in a European PE fund) however I hardly see a return to the franc or the DMark for that matter.

You have to remember how terrible the situation was back in the 80ies when each country was playing with its own currency, running devaluations as soon as they needed to give a boost to exports (Italians were the big specialists), etc. It's very complicated to run a unified market in these conditions. My (personal) view is we've gone too far in Europe with the integration to go back to national currencies. We'll do whatever it takes to preserve the euro.

In addition, I think people may be getting too nervous with these funding issues. I know it was different back then but in 1993, when Greece was still with the Drachma currency, it used to borrow at... 12%. 6 is not that bad?

Anyways, happy to read more thoughts on all this and just my 2 cents, I'm not in my area of expertise here.

 

I think another question is, who here is prepared to lose their job when the entire European financial services sector implodes?

Have a nice morning :)

 

im going to throw up.... The U.S. taxpayer is on the hook for the greek bail out for about 50 billion. If greece does not get a bail out, the market will tumble. Times are madness.

"The higher up the mountain, the more treacherous the path" -Frank Underwood
 
GoodBread:
If Europe gets off the Euro, fx traders and global macro funds are going to have a field day.

I will be able to pay for next semester loan free if it happens (SUNY tuition ftw)

 

With respect to your comment on inflation, I have to disagree. Overall inflation has been flat, and will likely be below normal levels for at least a few years. The high level of unemployment, along with the falling labor costs, do not place on pressure on overall inflation or a loss of purchasing power for the USD.

The rise in prices of gold and oil are not the result of a weakening dollar, but rather a supply and demand issue, and possibly a speculation issue as well. Often times oil and gold are viewed as closely tied to inflation, but the reality is that their correlation has dramatically decreased over the last couple of decades. While the increased oil prices will cause some other items to increase in price, it won't be like the 1970s where oil prices caused 10% annual inflation. It will probably have a very slight effect at most. Gold has been rushed too as a store in value, but there is a very limited supply of gold, so the upward pressure is most likely a result of speculation than large investors making a massive shift from dollar to gold (there's just not enough gold).

In terms of money supply, when it increases overall you do see an increase in inflation. However, even with the government's massive infusion of cash, this has not really increased the money supply. Keep in mind that the securitization market accounted for a huge portion of money available, as did bank loans. When securitization dried up, and bank loaning tightened, a massive amount of capital was removed from the economy. The government's money infusion managed to replace a lot of this, but it did not cause an increase in cash in the system overall. The only way that the additional government stimulus will cause inflation is if private sector lending and securitization were able to dramatically ramp up and come close to pre-recession levels, which is just not going to happen. I'm not saying it was the right or wrong thing to do, just saying that that's what happened.

I think the dollar will see some problems in the long run, but in the time frame you're talking about, especially with the continued trouble in the european system, the dollar should continue to see some strength. I think there are a hand full of currencies that may appreciate against the dollar (e.g., Canadian dollar, Brazilian Real), but overall the dollar will still be the reserve currency for the next few years.

 
Banker88:
Don't know what will happen, but at least this will prevent the creation of an "Amero" currency to be shared between Canada, the US, and Mexico.

haha, true. Although a shared currency wouldn't be way too bad if we could just keep Mexico out of it (via high barriers of entry).

"If you can count your money, you don't have a billion dollars." - J. Paul Getty
 
San Franciscan:
Banker88:
Don't know what will happen, but at least this will prevent the creation of an "Amero" currency to be shared between Canada, the US, and Mexico.

haha, true. Although a shared currency wouldn't be way too bad if we could just keep Mexico out of it (via high barriers of entry).

Canadians dont want to have anything to do with Pissos and American Monopoly money...theyll never let either in

 
Best Response

I definitely think a lot of this is overblown.

Ireland is stable and perfectly capable of servicing its own debt. Portugal also has plenty of wiggle room since it's total debt is still only 74% of GDP, and their deficit reduction policy is in place. Greece is raising red flags all over Europe. While Spain and Italy aren't exactly bastions of economic dynamism, with borrowing rates where they are both will remain very much solvent.

Most EU countries involved in the 110 billion euro bailout will start ramming it through their legislative process by Friday (France I believe already passed their slice) and inflows to Greece will begin shortly. In two years a lot can change, and while the rioting definitely looks bad in the press, it doesn't seem to have swayed Greek policymakers. Germany as well as its banks (DB included) have committed to Greece, and the ECB is even taking junk bonds as collateral.

The obvious weakness to my arguments is that it's a self fulfilling prophecy, and as rating agencies keep downgrading the eurozone's sovereign debt, investors will charge higher interest rates in a vicious cycle.

While none of this is great for the euro (I'm shorting it as we speak), I feel like over the long term it's going to push back up to 1.35.

Thoughts?

 

The vicious cycle point is I think the key one. I think it's also key to bear in mind how long this bailout took to put together; it's highly questionable whether the EU has the political will to pull off another one if they have to, especially given how much faster the next PIGS (I'm taking IRL out) could deteriorate, and as Greece demonstrated, the longer you wait, the worse it gets, and the bigger the bill gets. If that PIGS is Spain, I don't see the EU putting together a trillion+ package. To use the LEH-BSC analogy, it's pointless to stop the first domino if you let the second fall.

As for EUR/GBP that depends on the election; though I do think Britain's fiscal woes are a bit overplayed, their public sector is grotesquely large, and serious belt-tightening (supposedly) won't be easy in a coalition government.

 

Get real, guys, the EU will not abandon the Euro. It is possible albeit unlikely that Greece will be kicked out, though.

I think the downward trend in USD/EUR is due to flight to quality and order flow driving the rate down. I don't see it dropping further for an extended amount of time, due to the PPP arbitrage opportunities that would arise at such crazy levels.

Don't forget some states in the US (Cali) have similar problems and might need a bailout from the Fed Gov.

 
maxc:
Get real, guys, the EU will not abandon the Euro. It is possible albeit unlikely that Greece will be kicked out, though.

I think the downward trend in USD/EUR is due to flight to quality and order flow driving the rate down. I don't see it dropping further for an extended amount of time, due to the PPP arbitrage opportunities that would arise at such crazy levels.

Don't forget some states in the US (Cali) have similar problems and might need a bailout from the Fed Gov.

Agreed. Very few people have an interest in abandoning the Euro. The eurozone wants to get past this, so they can get back to expanding, not downsizing. They have Poland, Czech Republic, Bulgaria and Hungary on the sidelines thinking about when they'll join. Poland will be a prize acquisition of the eurozone. But first the eurozone has to figure out some say to deal with the laggards.

 

BNP Paribas seem to agree:

<span class=keyword_link><a href=//www.wallstreetoasis.com/company/bnp-paribas>BNP</a></span> Paribas:
We have revised our EURUSD projection sharply lower and now expect a decline to parity by Q1 2011. While we have had one of the most EUR bearish forecasts in the market, these previous projections now appear too moderate given current developments. We had feared that the structural weakness of the eurozone, due to the increasing economic divergence, would make it more difficult to obtain an optimal policy response. This has played out, but the inner EMU bond spread divergence and its impact on capital flows has been more severe than had been initially anticipated.

European bond markets are no longer a homogenous entity, which has reduced their attractiveness to foreign investors. Over the past year the net inflow into European sovereign debt markets has collapsed. Official accounts, which had been steady EUR buyers and bond investors for years have disappeared. Of course, we would not expect central banks to adjust existing Euro holdings, but incoming reserves will no longer be reallocated into Euros. Peripheral credit risks have reached elevated levels despite Europe having already played its fiscal transfer option. This observation convinced us to move our EURUSD call sharply lower.

Now that the fiscal option has been used without much success it will be down to the ECB to come to the rescue of the EUR. But, ECB President Trichet did not leave the impression that this rescue comes at speed. There is still too much talk of securing price stability while the real problem is deflation. Currency markets tend to anticipate paradigm chances. Europe will change from using fiscal tools, attempting to heal European divergence with monetary instruments, sending the euro massively lower.

http://ftalphaville.ft.com/blog/2010/05/06/222446/bnp-paribas-calls-for…

 

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