Market Insider

Euro could finally reach parity with the dollar

Euro to bounce back?

The euro may finally reach parity, or trade one-for-one with the dollar, now that the Federal Reserve may have given a shot in the arm to the U.S. currency.

The move has been expected for a while, but the euro surprisingly strengthened after Italy voted against constitutional reform in early December. Euro weakness against the dollar resumed after last week's European Central Bank meeting, and accelerated after Wednesday's Fed decision on rates.

The euro was near $1.042 in late trading Thursday, after hitting its lowest level against the dollar since 2003, at $1.0364 earlier in the day.

"A lot of people figure the door has been opened here for parity on the euro," said Carl Forcheski, director of corporate FX sales at Societe Generale.

"We've broken through so many supports lately that the next level of support is parity, 1.00," he said. That's about 4 percent weaker than where the euro was trading Thursday afternoon.

Euro-dollar (2001 - 2016)

Source: Reuters

In the last few weeks, the dollar index strengthened to levels not seen in more than a decade, and Treasury yields climbed on hopes of greater U.S. economic growth on promises of tax cuts and more from President-elect Donald Trump.

Those moves accelerated in the last two days after the Fed surprised on Wednesday by forecasting three rate hikes in 2017, one more than the consensus estimate for two increases. The U.S. dollar index jumped to its highest since December 2002 and shorter-end Treasury yields leaped to multiyear highs.

"We're still in the middle of this rally" in the dollar, said Win Thin, global head of emerging markets strategy at Brown Brothers Harriman. "I don't think we're near the end but we're a fair way through it."

Thin pointed out that on a real effective exchange rate basis which adjusts for inflation, the dollar gained roughly 35 percent during the Clinton administration in the 1990s, but has only climbed about 25 percent since President Barack Obama took office.

As a result, Thin expects the greenback to strengthen another 5 to 10 percent into the end of next year as Trump likely implements business-friendly policies and the Fed raises rates.

Real trade-weighted US dollar index

Dollar strength puts pressure on the earnings of U.S. corporations with operations overseas, commodity prices and on emerging markets, whose large levels of dollar-denominated debt becomes more expensive to pay off.

But Tim Hopper, chief economist at TIAA Global Asset Management, said gains in the U.S. dollar should be limited as other currencies find support from the spread of government stimulus to other regions such as Europe.

"As long as we get increased fiscal spending in Europe you'll see support in the euro as well," he said. TIAA expects the euro to reach $1.10 by the end of 2017.

Other firms also expect the euro the recover slightly over time.

Societe Generale forecasts the euro to recover to $1.09 by the end of next year after hitting $1.00 in the first quarter. UBS said in its 2017 market outlook this week that it expects the euro to reach $1.20 in the next 12 months.