The euro is on the verge of parity with the US dollar for the first time in two decades.
Europe’s common currency has already hit a near five-year low of $1.03, turning to the greenback as a haven from market turmoil and the war in Ukraine.
This prompted HSBC Holdings and RBC Capital Markets to speculate that the two would achieve parity in 2022.
Hedge funds are already betting on this.
They have piled up over $7bn in notional value in options bets at parity in the past month alone, making it the most popular trade among those looking for further downside in the common currency.
“The euro in itself is not an attractive currency at the moment,” said Francesco Pesol, currency strategist at ING Group NV.
While the Dutch bank is keeping its official euro forecast for the next six months at $1.05, the paysol acknowledged the strength of the dollar and market volatility means parity is likely.
The euro’s plight is largely a function of the dollar’s strength, which has been supercharged as the Federal Reserve raises larger interest rates than its peers.
A fresh bout of global risk aversion that has taken a toll on equity and credit markets is only moving in haven currencies.
There is also a dark outlook for the European economy.
The ongoing standoff with Moscow over the supply of natural gas to the continent has raised the prospect of an apparent recession. The International Monetary Fund has cut its 2022 growth forecast for the currency bloc to 2.8 pc.
This is why the European Central Bank is running a tightrope.
It has to balance the need for tougher policy to cushion record inflation against the potential for economic damage – especially in some of the region’s most indebted member states, such as Italy.
Though officials may raise rates above zero before the end of the year, further hikes are doubtful.
Investors will also be looking to the minutes of the bank’s April meeting on Thursday for further clues on thinking, along with speeches by the likes of ECB President Christine Lagarde in the coming days.
Ms Lagarde joins a crowd of policymakers indicating an increase as early as July.
“I think it’s very difficult for many people in the ECB to see that inflation hasn’t peaked yet,” said Peter McCallum, rate strategist at Mizuho International plc. “Unless we talk about a 50 basis-point increase, it is difficult for many hawkers to surprise the market.”
Any renewed sell in the euro that breaks the January 2017 low of $1.0341 – nearly touched both Thursday and Friday – could set the currency up for further losses.
According to strategists at HSBC Holdings plc, including Dominic Bunning, the money market could begin to factor in credit risks in the euro area, with sector bonds also being dumped.
The spread between Italian and German yields – seen as a risk gauge – this month topped 200 basis points for the first time since the early days of the pandemic.
Not everyone is negative.
Roberto Mialich, a currency strategist at UniCredit SpA, expects the euro to climb above $1.10 over the course of the next year as the Fed’s hiking cycle comes to a close.
He sees a permanent below-parity scenario only as a tail risk, and possible only if eurozone growth is much higher than feared.
Yet as long as riskier assets remain weak, traditional havens such as the dollar and yen will remain in vogue.
Russia’s war in Ukraine also remains a major obstacle for the euro, especially given the potential for further disruptions in gas supplies.
“The euro has already faced more downside pressure than we expected, but we find it difficult to see a silver lining for the single currency at this level,” HSBC strategists wrote in a note. inflation. “It’s a dirty cocktail to try to digest any pose.”