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– Euro in crisis
One might think that the worst is behind us, for the euro against the dollar (EUR/USD or euro/dollar), some bad news on the European economic front having already been integrated: structural recession in Germany, economic stagnation in other countries, consumption lagging behind… But two additional factors could worsen the situation of the euro against the dollar and even push the currency pair towards parity.
Between Europe and the United States, it’s “Catch me if you can.” The first factor that could cause the euro to fall to one dollar is American economic and stock market outperformance. Just look at the evolution of the flows. For example, in the week of November 5-13, US ETFs and mutual funds attracted $56 billion. This is the second largest weekly inflow since 2008. International investors are now only betting on the American economy.
The euro plunges to its lowest level against the dollar in two years: what is happening?
The dollar is structurally supported by capital inflows
Consequence: incoming flows from Europe and emerging countries are reaching record levels, which structurally supports American stocks and the greenback. While growth in the United States is expected to reach 2.7% this year, it will be at best 1.2% in the Eurozone. In a recent study, Barclays shows that over the last ten quarters, American stocks have outperformed European stocks.
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Result: when you are a saver or an institutional investor and your priority is to obtain yield, it is in your interest to invest a large part of your assets in dollars. The resulting capital flows structurally support the dollar which is overvalued by 9% compared to the basket of reference currencies, according to our calculations. This is unlikely to change.
European political instability weighs down the euro against the dollar
Second reason for pressure on the euro, the resurgence of political risk in Europe. For the first time in a long time, the main European governments are facing complicated electoral deadlines or a risk of the fall of the government in 2025. This is the case in Spain, France, Germany and the Netherlands. The return of politics to the fore has a repulsive effect on non-European investors.
Let's take the case of France: since the early legislative elections in July, Japanese investors – who are cautious in their asset allocation – have been net sellers of French sovereign bonds. This will not get better if a motion of censure brings down the Barnier government before Christmas. Even if we should never exaggerate the impact of politics on financial markets in the long term, it is certain that the degraded context in Europe will not help the affairs of the single currency.
Forex: what is it? Why invest?
«It is not on the side of the monetary policies of the ECB and the Fed that the fall of the euro against the dollar could experience a respite»
The United States and Europe face risks of different kinds. For some, the ECB could accelerate its rate cut movement to restart the machine. While on the American side, the Fed could be forced to take a more pronounced pause due to a return of inflation. In our opinion, none of this will happen. On the European side, the ECB is not in the habit of rushing. On the American side, Powell reiterated, there is no indication that inflation would increase due to the return of Trump.
In other words, it is not on the side of monetary policies that the fall of the euro against the dollar could experience a respite. In the foreign exchange market, there is an implacable law which always ends up winning: the exchange rate of a currency reflects the state of its economy. A struggling economy must have a weak currency. It is, in a way, a return to normality for the EUR/USD pair.
