Don’t let the tree of parity keep from seeing the forest of the exchange market
In the field of currency, euro-dollar parity is the topic du jour. However, it is of little importance beyond the psychological and media effect. What is important is the trend over the last several months. The European currency has lost over 11% in value this year compared to the dollar, which has led the exchange to an almost 20-year minimum. In practice, these facts only reflect the preference of financial flows for the US currency. However, looking at the market as a whole, it seems that these events are signaling more a strengthening of the dollar than a weakening of the euro. In the end, this is what will determine the impact on both the value of European assets as well as its economic activity.
The dollar has remained almost constant in most of its crosses. This is due mainly to the US Federal Reserve's restrictive monetary policy. This not only raises interest rates, which increases the appeal of US government debt, but it also translates into a liquidity drain, that is, removing some of the dollars that are circulating from the market. That is why the dollar is worth more. In fact, if the ECB did the same, the exchange rate would remain approximately stable, but it is clearly behind and questioning the right course. The last factor in favor of the dollar, which is more recent, is the collapse of expectations for growth almost all over the globe. This promotes American assets as a refuge, thereby increasing the appetite for dollars. These elements do not look like they are going to change in the short term, especially after the latest CPI figure from the US, which seems to confirm the Fed will increase rates by 75 basis points. Therefore, unless there is an abrupt about-face from the ECB, it seems that this trend will continue.
The consequences of this trend on European assets and the economy, while not immediate, are negative. A cheaper currency can help exports, especially in a region with open trade policies like Europe, and therefore, act as a cushion against slowdowns in activity. But this time, that is not the case. The cross with the dollar is not the only one that matters; on the whole, the euro has not fallen much in terms of its effective exchange rate, i.e., in a weighted average compared to the currencies of its main trade partners. But it has lost value compared to the dollar, the currency in which most oil payments are made, and it also has lost significant value compared to the Brazilian real or Russian ruble, for example. In general, it has sharply fallen compared to suppliers of raw materials and energy. On the other hand, its value has decreased much less or even remained the same compared to the currencies of large foreign customers such as China, the U.K., Japan, and Turkey. Therefore, the overall effect of this combination is inflationary, but it does not provide the increased competitiveness that would help foster growth through more exports.
As a result of the above, the trend of the euro crosses in recent months adds pressure to the ECB due to their inflationary potential, which is also causing European governments to tremble given its social and electoral impact. But if the ECB fights inflation with an aggressive monetary policy, it could help raise the euro's value not only compared to the dollar, which would be part of its objective, but also compared to other currencies from countries that buy European goods, thereby further damaging growth. “Parity,” therefore, can be added to the list of the ECB's dilemmas, and it does not seem as though it will reverse in the short term.
Alberto Matellán, Chief Economist at MAPFRE Inversión