Introduction

In recent years, the financial markets and the economy have experienced some unexpected events. The EUR reaching parity with the USD is one of those notable moments and one that is worth remembering. 

The last time the EUR and USD currencies were at parity was 2002, three years after the EUR had come into existence. 

The geopolitical situation in Europe in recent months is one of the factors that has led to this however looking at this chart you can see the EUR has been in decline versus the dollar for a while now.

There are different reasons why the EUR has been on the decline when compared to the USD. Factors or events such as the Great Recession, Brexit, The Pandemic and other notable events that have caused investors or speculators to a degree, to see deem USD more favourable than the EUR.

Parity Explained

Parity means the state or condition of being equal as a simple google search revealed, and within the context of Forex Trading, this definition is apt.

You can visualise this further by looking at a forex quote of two currencies (called pairs) so we will use the EUR and USD.

If these currencies are in parity, it means you can exchange the same amount of EUR for USD, barring any transaction fees, and not lose any purchasing power.

Why is the EUR USD Parity Important

The European Union has 27 member countries and some of these countries have adopted the Euro which is denoted as EUR as their currency. This includes countries such as France, Germany, Italy, Spain and Portugal.

The Euro Area consists of world’s the third largest GDP, behind China and the USA as we can see here in this link.

The EUR/USD is one of the largest traded currency pair simply and as a currency pair, it represents two of the largest economies in the world. The Euro like any other currency is influenced by economic activities and the decisions carried out by the European Central Bank, in the case of Europe.

In the past two years, there has been a number of significant events economic, social and political that have caused the central bank to make decisions that have impacted the Euro.

Factors such as the unemployment rate, interest rate, inflation, overall economic health, balance of trade and a number of other factors can determine how investors view the health of the currency and the countries that have adopted that currency.

Investors may choose to be bearish or be hawkish and will take positions i.e buy or sell assets denominated in that currency or sell the currency for another in order to maintain a stronger purchasing power for different reasons.

Using the example of the EUR/USD, investors may choose to go long – or buy the USD while selling the EUR because they feel the US economy is more robust and has taken measures to deal with inflation. 

Conversely they may feel that the economic prospects of the EUR is not looking good; the political instability and conflict in Ukraine coupled with high inflation so as a result they may choose to sell EUR and buy the USD.

EUR/USD Parity Chart

This is the moment (link) where the EUR was in parity with the USD and for a brief moment, it fell against the dollar to as low as 0.9998. This means at the time the EUR was weaker than one USD.

Why the EUR declining against the USD

High inflation, an energy crisis and the actions of the Central Bank and Fed are some of the reasons why the EUR is declining against the USD.

High Inflation

Inflation is an important measure of the health of an economy and where inflation is high, investors do not look favourably on the condition of the economy. You can read our article here on what high inflation is and the impact.

The European Central Bank (ECB) has not reacted in the way investors and other market participants expect in order to deal with the high inflation. The ECB raised interest rates but some market participants think it is insufficient to deal with inflation.

Secondly, simply raising interest rates still affects a large number of people negatively because some of the countries that have adopted the Euro have a better economy than others. Italy’s economy is not as stable as the German economy so a rate hike will affect them differently.

High inflation is not just a European problem – the US is also suffering the effects of high inflation however the inflation in the US is not caused by the same reasons as the inflation in the EU; more on this later.

The war in Ukraine and the sanctions that have followed means europeans are paying more for food and energy, with the same amount of money or even less thanks to inflation and in many cases little to no pay rises.

The Federal Reserve (US Central Bank) has taken measures to deal with high inflation by raising interest rates aggressively. This has caused investors to look more favourably at the USD.

The US is also not at the mercy of its neighbours for energy so this enforces the positive outlook for the US economy and US dollar as a result.

Energy Crisis

Europe depends on Russia for its energy needs and the events in the past week where Russia shutdown the Nordstream 1 pipeline for maintenance has investors worried because it could be revenge for the sanctions on Russia rather than maintenance.

At the time of writing this article, the Nordstream 1 pipeline is now open for Russia gas to flow so in the short term, crisis averted however it is a situation that can change due to the ongoing conflict.

Europe still depends on natural gas from Russia for its energy needs and energy prices are going up. So there is more demand because we need energy to heat our homes and fuel our vehicles, yet wages are not rising and the possibility that Russia may cut gas supply to Europe is a real concern.

Some European countries are already feeling the effects of Russia turning off its gas supplies.

This uncertainty has made investors even more cautious when it comes to the Euro and underlines why the USD looks more appealing and stable.

Prior to that, the events in Ukraine has put further pressure on people and exacerbated the effect of high inflation because there is less supply of wheat and other materials that are obtained from Ukraine, but the demand has stayed the same.

Other issues like Brexit, the Euro crisis and even the impact of covid and how it was managed has left investors loosing faith in the EUR when compared with the USD.

One important thing to note is that the USD is still the reserve currency and is far ahead when compared with the other currencies so many countries still prefer to hold USD as opposed to EUR.

Euro Dollar Forecast: Will the EURO go up

What goes up must come down as the saying goes. Looking at the prevailing economic conditions in Europe and the EUR, as long as the economic conditions remains the same, it is difficult to see the EUR going up and staying at any significant levels for a long period of time.

Now there may be a strengthening in the EUR against the USD and in actual fact there is a bounce from parity but how long will that last? It seems to be a prolonged dead cat bounce. Also, winter is coming and this can be a huge game changer for the outcome of the war in Ukraine, the energy crisis and everything else at play.

As we approach the colder months of the year, it should become clearer how things will play out because the conflict in Ukraine will either get worse or peace talks will start.

Peace talks or some sort of compromise will be a promising outlook because it reduces the likelihood that Russia will cut energy to Europe especially when it is needed the most.

Off the back of high energy costs, business may go bust because customers have less money to spend due to wages not rising in step with inflation and the cost of doing business will also go up.

If consumers are consuming less and business slows down, you can see how this can lead to a recession or even worse.

The EURO may gain in the short term but longer term, if these issues above are not addressed and prevail, then there is little hope that any gains in the EUR vs the USD above parity will last long.

What you should learn from this

There are a number of lessons to learn from this however we will highlight two of the main lessons.

1: Interconnectedness and Impact

Nothing works in isolation and as your financial knowledge improves, you will begin to learn that when something happens in the market, there is impact elsewhere in the market too and that may present an opportunity.

A better way to explain this is to think of the event, opportunities and asset classes that are impacted. In this case, the event will be high inflation and the asset class will be any asset class that can be impacted by high inflation either positively or negatively, and then taking action to benefit or mitigate the impact on your portfolio.

Another event can be Russia invading Ukraine – what is the impact and to what degree is the impact felt? Ukraine provided a large portion of wheat, barely and other products so the conflict has impacted that supply thereby causing a shortage and an increase in the price.

2: Hedging and Diversification

It is impossible to talk about diversification and hedging (which are two separate things mind you) in a single paragraph. As an investor, it is crucial to observe what is happening in the market and hedge against it.

Hedging simply means you are protecting yourself from any downside movement that can affect the value of your assets. In this case, it could be purchasing dollar assets since that currency is stronger.

Diversification allows you to minimise the impact of a downturn from one particular segment of the economy on your portfolio. So rather that leaving your assets EURUSD, you can look at other assets or in other regions that are less impacted by the situation in Europe – assuming you are in Europe and have assets denominated in EUR.