Don’t be fooled by this sudden rebound.
The accompanying euro price chart shows that the euro has had a long, almost uninterrupted descent. After hitting closing highs of $1.3934 on March 18, 2014, it fell all the way to $1.0484 on March 15, 2015. That’s a 25% freefall for the currency against the dollar in just about a year.
It was then that all the predictions for euro-dollar parity began to ramp up. We’ve said before the euro is going to achieve euro-dollar parity sometime in mid-to-late 2016. But we also acknowledged that it’s going to hit some snags on the way down.
The fundamentals support a fast dive to euro-dollar parity. But the technical traders simply won’t allow it to fall to those levels so quickly.
Since bottoming out at 15-year lows last month – at $1.0484 – the euro closed at $1.1224 yesterday (Thursday). That’s a 7.1% gain in little more than a month.
This isn’t because there was any reason to believe in the strength of the euro. For the most part, hitting $1.0484 was a technical extreme. All it took was a weak earnings season fueled by a stronger dollar to give traders a reason to start buying euros again.
Make no mistake about it. This bump is temporary. The euro is not suddenly going to take off. No fundamental indicator in Europe supports a stronger euro, even if the technical traders are wary of selling down to euro-dollar parity so quickly.
Here’s why euro-dollar parity will still happen, even if it does snap back a little on the way down…
Why Euro-Dollar Parity Is Not Far Off
The Eurozone has two key headwinds working against the euro’s strength that will ultimately fuel this long-term downtrend to euro-dollar parity.
The first is European Central Bank quantitative easing.
The 60 billion euro ($67.2 billion) a month central bank purchases of Eurozone government sovereign bonds and other assorted assets is aimed at kicking the slow-growing European economy into shape.
But it’s much less about helping the broader currency bloc than it is a giveaway to the banks.
You see, in 2012, ECB president Mario Draghi pledged to do “whatever it takes” to save the euro. Anyone well-versed in central bank speak knew what that meant. It was a signal to banks that were wary of purchasing the high-risk, high-yielding debt of Portugal, Italy, and their ilk to take the risk. If worse comes to worst, their old pal Draghi would be there to help them out.
After two-and-a-half years of purchasing shaky government debt and driving down the yields on the weakest Eurozone bonds, European banks had a problem. They had no one to buy the debt they loaded up on. Enter Draghi.
In January he announced ECB QE. This bond-buying scheme would attempt to wipe clean the banks of the debt they loaded up on – which had since climbed in face value with the crashing yields – and bolster their reserves that they could then use to lend.
ECB QE doesn’t by itself encourage inflation. The banking system being flooded with excess reserves is all but useless if those reserves aren’t lent out. ECB QE may be aimed at curbing the troubling, demand-killing deflationary spiral Europe was falling into, but ECB QE is not powerful enough to force consumers and businesses to borrow.
Regardless of how successful ECB QE can be in bolstering prices across the Eurozone and sparking inflation, it’s going to put sell-side pressure on the euro. QE is expected to last until September 2016, and until then, the Eurozone is going to be under the thumb of Wall Street trading desks and speculators who are looking to make a killing trading the euro’s volatility in an uncertain economic environment.
That’s why there will certainly be a prolonged descent. But there will also be some violent swings up as the euro approaches multi-year lows like it did in March and the technical traders make their moves.
Add to ECB QE the ticking time bomb that is Greece and there’s no reason to think the euro has a reason to rally.
Greece’s Role in the Euro-Dollar Parity Descent
Greece is loaded up on unpayable debt.
It has been made even more unpayable by further bailout loans from the International Monetary Fund and the European Union – the debt is now at 175% of Greek GDP. Greece can’t jump from one bailout to the next and remain solvent. It needs to either default now or leave the euro, reissue the drachma, and default then.
Either way you have a situation where the euro is in question as a unifying currency. If Greece can mount unsustainable debt and then default its way back to prosperity (or relative prosperity), why would any Eurozone country feel obligated to pay their bills should they run into trouble?
Add to that the number of derivatives contracts and cross-hedges tied to Greek debt that have the potential to unravel and crush Greek banks should a default happen and you’re talking not just about a simple Greek default, but an all-out derivative-fueled contagion.
“They’ve all cross-collateralized over there, so Greece’s debt is spun out to France, banks in Germany, banks in Italy – Europe is this huge spider web of cross holdings,” Money MorningChief Investment Strategist Keith Fitz-Gerald said. “We don’t know how big it is exactly because we’re not privy to all those contracts. Draghi certainly is privy to Eurozone contracts in that scenario.”
It’s unknown what a Greek default will mean, or how long Greece can hold out. And that’s a problem.
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