The euro, already shot this year to a two-decade low, remains an unloved currency under relentless pressure as its economy stumbles into recession.
It hangs just above parity with the dollar, after a brief dip below that level earlier this month for the first time in more than two decades. The currency has become a lightning rod for growing pessimism about the eurozone economy. It has fallen more than 10% against the dollar this year, and many analysts say the likely direction from here is more downside.
Much of the economic gloom centers on the disruption of Russian energy supplies to Europe, which particularly threatens German industry. Credit Suisse predicts a 50% chance that the euro zone will fall into recession over the next six months. Goldman Sachs says it may already be in one.
Italy is also a big concern amid political unrest that led to the departure of Prime Minister Mario Draghi. S&P Global Ratings has downgraded its outlook on the country’s debt, and a key indicator of risk, the spread of Italian bond yields to those of Germany, is about the highest since 2020. Nerves at the idea that Italy leaves the euro manifests itself in credit default swaps, although it is considered a very remote risk.
From a price point of view, the euro is doing even worse than in 2012 – the low that year was $1.20. It was trading around $1.02 after slipping to 99.52 US cents on July 14.
JPMorgan Chase and Rabobank see it going down to 95 cents given Europe’s exposure to the energy crisis. Option pricing puts the odds of reaching parity by year-end at around 70%. The Bloomberg consensus forecast for the end of the year is $1.06.
But despite all the negativity, there is little talk that the region is heading for another existential crisis like the one it suffered a decade ago, when high debt levels and soaring bond yields led to speculation that the region could burst. This ultimately led Draghi – at the time president of the European Central Bank – to say he would do “whatever it takes” to protect the currency. A schism is a fringe thought now, and the ECB has moved faster to control the markets.
“In some ways the situation is more serious than 10 years ago, and in others more benign,” said Themos Fiotakis, global head of FX & EM macro strategy at Barclays Plc. “It’s less of a deleterious problem for the integrity of the euro as a currency. But economically, growth could prove to be a bigger problem than it was then.
Much of the currency depreciation is tied to this poor economic backdrop, marked by a mix of slowing growth and soaring inflation. On Friday, data showed Germany – Europe’s biggest economy – stagnated as inflation in the 19-member currency bloc soared to a new record high of 8.9%, beating forecasts.
Monetary policy divergence is also part of the mix. The ECB raised interest rates by 50 basis points last week, but the Federal Reserve has tightened more than four times more this year after adding another 75 basis points to its benchmark on Wednesday.
Predictions of a breakup of the euro zone have not completely disappeared. The founder of the macro hedge fund EDL, Edouard de Langlade, says it is possible and is aiming for a euro-dollar rate of 80 cents.
But the ECB is proactive, as distant as it is. Along with its rate hike this month, it unveiled a new tool to prevent fragmentation, where there is an unwarranted divergence in euro member debt spreads.
“Today the main risk is inflation risk,” said Nicolas Forest, head of global fixed income at Candriam. “The most important message was how the ECB can normalize the situation, without creating a debt crisis. The idea now is to avoid something, not to fix something.
The work of the ECB is complicated – and not for the first time – by Italian politics. The country will hold elections in September and a right-wing alliance is currently leading in the polls. Bond prices move on concerns about the policies of such an administration, making it difficult for the ECB to step in and say market moves are unwarranted.
Yet far-right leader Giorgia Meloni plans to stick to European Union fiscal rules if she leads the next government, according to officials familiar with her thinking. Investors say Italy is unlikely to back down on its commitments and jeopardize access to around 200 billion euros in European Union funds.
This support is to be disbursed under the NextGenerationEU program – a major breakthrough in budget sharing triggered by the pandemic, and which separates the current EU from the EU of past crises.
“It was Europe crossing the Rubicon that no one thought they could cross,” said Rohan Khanna, strategist at UBS Group AG. “It was a highlight of European integration. There are still cracks, but it’s a very different world than it was in 2010.”