Why the Euro Has Tumbled Near Parity to the US Dollar

1. Why is the euro sinking? 

Europe suffers most from the war, which has sparked an energy crisis and could lead to potentially a long and deep recession. That places the ECB in a difficult position — trying to curb inflation and cushion a slowing economy — as it aims to raise borrowing costs for the first time since 2011. At the same time, the US Federal Reserve is raising interest rates much faster than the 19-nation euro area. That makes yields on US Treasury bonds higher than those on Europe’s debt, driving investors to the dollar and away from the euro. What’s more, the greenback benefits from its status as a haven, meaning that as the war drags on and the fallout gets worse, the euro keeps sliding.

2. Why is a weaker currency bad?  

For years, policy makers have welcomed a weaker currency as a means to stimulate economic growth, since it makes the bloc’s exports more competitive. But now, with inflation in the euro zone at the highest since such records began, its weakness is undesirable as it fans price gains by making imports more expensive. In June, euro-area consumer prices jumped 8.6% from a year earlier. Some policy makers have highlighted a weaker euro as a risk to the central bank’s goal to return inflation to 2% over the medium term, although the ECB does not target the exchange rate. Still, when measured against other currencies apart from the dollar, the euro looks more resilient.

3. Is the 1:1 level important? 

Yes. It’s a psychological threshold for the market. The first time the euro fell to parity with the dollar was in December 1999, not even a year after its inception. Just like now, analysts then pointed to a widening in the spread between German and US bond yields and stronger US growth. It was a dent in the pride of Europeans, who saw the common currency as an important political project and a rival to the dominant dollar. Today, the euro is considered one of world’s key currencies for transactions and reserves, though hitting parity is still symbolic. For the financial markets, currency traders expect turbulence around the 1:1 level given that billions of euros in options bets are linked to that big line in the sand. 

4. Where’s the floor? 

It’s hard to say. Some analysts predicted the common currency could slide to 90 US cents if Russia escalates the crisis by withholding more gas supplies to Europe. Since the start of July, options traders have been laying more bets at around the $0.95 level, with $0.9850 potentially acting as a short-term bottom, according to trade data from the Depository Trust & Clearing Corporation. Deutsche Bank strategists have calculated that a slide to $0.95-$0.97 would match the all-time extremes…