Euro/Dollar Parity: Illusion or Reality?

2002. Since Spain's entry into the European Union, 2002 became one of the most important years in the country's modern history as it adopted the euro as the single currency. The peseta ceased being legal tender, which opened a new chapter, not only in Spain, but also in the other eleven states that accepted the new currency that same year, launching a new socio-economic paradigm on the continent. Since then, there have been ups and downs, good times and bad times, such as the financial crisis of 2008, which called into question the resilience of the euro. In fact, it was in 2012 that then president of the ECB, Mario Draghi, was compelled to send a message of strength to save the euro in any way possible.

Coincidentally, the euro reached parity with the dollar exactly twenty years ago. Now the situation has now been repeated, this time spurred by factors linked to the war in Ukraine and the supply crisis brought on by the pandemic. Experts point out that when an economy experiences high inflation, interest rates are often raised to protect the viability of the corresponding currency. The problem is, they say, that the issue at hand is both simple and complex: simple because, according to Daniel Sancho, chief investment officer at MAPFRE Inversión, the reading on both sides of the Atlantic is quite different (because of geopolitical issues and diverging central bank policies); and complex, at least in Europe, due to the challenge of developing a common policy among all member countries.

Alberto Matellán, chief economist at MAPFRE Inversión, believes that, a priori, it is a psychological matter, but that it “calls on us to reflect on the trend of the exchange rate and what is behind it.” The reality is that the dollar/euro exchange rate has been on a steep trajectory since February, falling by around 10% at a somewhat alarming rate, according to Matellán. But the focus is not so much the weakening of the euro as it is the “strengthening of the dollar.” From a basic viewpoint, this scenario can be seen as a boost for exports from the eurozone. However, even if this is true, he acknowledges that it is not a good thing for Europe:

“A strong dollar implies a liquidity squeeze with the rest of the world (a negative situation for both Europe and emerging countries) and has a negative impact on the European balance,” he explains.

The problem, he acknowledges, is that “the depreciation is only against the dollar,” not against the currencies of countries trading with Europe. As a result, “imports in dollars become more expensive, while exports for client countries are not made easier.” He concludes, “the net effect of the trend is negative.”

Is the ECB then obliged to strengthen its rhetoric? The consensus of analysts points to the inaction of the body chaired by Christine Lagarde, and the rapid and aggressive response of the Fed, as one of the reasons why the exchange rate is at these levels. The spotlight now turns to the ECB’s next meeting and whether they will be able to strengthen their rhetoric and raise interest rates by 50 basis points.

From an advisory point of view, Daniel Sancho reminds us that these happenings add a point of unwanted volatility in the most prudent portfolios, making active management all the more important.