Will EUR/USD Reach Parity?

With the yield spread widening, it seems only a matter of time until the Euro reaches parity with the US dollar, but there are still some obstacles that could stop it.

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Time for a rebound?

Last week, the EUR/USD rate dropped to the lowest it's been in more than five years. Since then, there has been a bit of a pullback within the downtrend, as might be expected from such a move. As both the US and Europe have put the pandemic behind them, the driving force is the expectation of interest rates going forward.

Both the Eurozone and the US have extraordinarily high inflation, although in the EU it's a little less than in the US but perhaps catching up. However, monetary policy has been quite different; the ECB is only now talking about raising rates in July. The consensus is by 25 basis points, though yesterday Dutch central banker Klaus Knot was the first to hint at a 50bps hike.

The gap keeps widening

Meanwhile, the Fed has already hiked by 75bps and is expected to add another 50bps at least at the next meeting. In total, the ECB is expected to raise rates three times this year, which would leave the rate at +0.25%. In comparison, the Fed is expected to raise rates by 6 more times this year, reaching +2.5%. In terms of monetary policy, that's a major difference.

Especially when we consider that Eurozone inflation is 7.5% at the latest reading, compared to 8.5% in the US. In other words, there is currently a 1.0% spread in inflation and 1.5% spread in policy. With both major economies having similar credit ratings, it makes fiscal sense to keep funds in dollars. This spread would be expected to keep pushing the EUR/USD down eventually to parity - unless there is a major shift in the underlying economic situation.

Following the disappointing consumer data from the US, worries have increased that the world's largest economy is slipping into a technical recession. If Europe manages to eke out growth in the comparable period, then there could be a compelling fundamental argument for a turnaround in the currency pair.


EURUSD discants itself from parity

EURUSD has been under severe pressure for a while. In fact, it reached major 5-year support at the low of $1.0349 last week, forming a double bottom. Coincidentally, prices rejected the trendline support extending down from the highs of $1.2556 and $1.1494. This is short-term bullish combined with the stochastic divergence.

Interim resistance can be observed on the swing low of $1.0636. Together with the 5-year support at $1.0340, which just formed a double bottom last week, they form a dynamic ascending trendline extending shy of $1.0900. $1.086 is a swing resistance. Above the former a major resistance awaits bulls at $1.1185. This could be where the correction ends.

Source: Spreadex trading platform

Key Takeaways

Despite the US having only 1% higher inflation than the EU the Fed is way ahead in the hiking cycle and that spread leaves the euro under pressure. Expectations of forward rates widen the spread between the two currencies but there is some scope it could narrow and support the euro if the US economy goes into a technical recession.