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Could euro hit parity in 2016?

Could euro hit parity in 2016?

The euro appears to be on course for its second successive 10% decline in the past two years. At the beginning of 2014 the euro was trading at 1.37 and by the time it closed the year we had declined to levels just above 1.2000. As we head into the end of 2015 we’re on course to post yet another 10% decline with speculation rising that we could well see further declines towards parity, and levels last seen in 2002. This year’s low currently sits at 1.0460 and despite a brief rebound to 1.1700 in August the euro has spent much of the last two months trading steadily below 1.1100 raising speculation that we could see a fresh push below 1.0800 and another attempt on the March lows and on to parity. Speculation that we could see further easing measures from the European Central Bank and another rise in US interest rates has seen money flowing into the US dollar widening interest rate differentials between the two currencies to multi year highs so much so it is hard to find anyone who thinks we won’t see another crack at parity in the New Year. Certainly it is hard to argue against the logic of a further widening of interest rate differentials but it is based on the premise of at least another two to three interest rate rises by the US Federal Reserve and a further easing of monetary policy by the European Central Bank. While both outcomes seem rather compelling the reality is likely to be that much harder to implement as ECB President Mario Draghi found out to his cost at the most recent December meeting, though he can certainly be happy that the ECB has fulfilled its part of the bargain in fostering the conditions for a rebound in economic activity in 2015. He may find things a little harder in 2016 given recent events. Having led markets to believe that he would deliver a significant stimulus boost in the weeks leading up to the most recent central bank meeting Mr Draghi was unable to deliver on his promises due to a growing core of dissent amongst a number of influential and smaller ECB policymakers against a backdrop of an improving European economy. In fact in Ireland, the current poster boy for European austerity GDP growth is rising at an annualised 6% per annum and it could be argued that the Irish economy needs a rate rise, not additional stimulus. There is no doubt that the outlook for Europe’s economy looks brighter than it did at the beginning of 2015 in the aftermath of the beginning of March’s €60bn a month QE program which is now slated to end in March 2017 and now extends to the buying of local government and city bonds. If anything this widening of the pool of assets available to buy highlights the core weakness of the ECB’s bond buying program in that simply speaking the ECB is running out of available assets to buy as Germany in particular issues less government debt. It is also questionable as to whether the lower euro has acted as the fiscal boost many policymakers think that it has, rather the decline in the oil price has been the catalyst for much of the rebound in economic activity seen since the March lows. As for next year much will depend on whether the Federal Reserve will be able to deliver on further increases in the Fed Funds rate and while the make-up of voting members in next year’s FOMC committee is likely to be of a more hawkish nature it remains doubtful whether the Fed will be able to deliver more than a single rise in rates against a continued weak inflation and wages outlook. The Federal Reserve could well be reluctant to push the US dollar even higher having overseen a 25% appreciation in the last two years, and which has introduced a significant chill to certain high value parts of the US economy. With a US election also looming in November any rise in rates will probably need to happen in the first half of next year simply because the Federal Reserve will be reluctant to get dragged into the political firing line at a time when the central bank has become more embroiled in the politics of the US economy than it would like. Quite simply after two years of 10% declines the euro parity trade is becoming a little too crowded and predicated on the fact that US rates could well be nearly 1% higher than they are now and European rates much lower. As we head into 2016 it seems more likely that the euro could well have found a short term base and may well trade in a much lower range between 1.05 and 1.2000, as divisions within the ECB governing council keep the room for further policy moves constrained, and the Fed fails to deliver in the same way it fell short in 2015. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

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