One to one One to one http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\currency-exchange-small.jpg August 5 2022 July 13 2022

One to one

Three reasons the dollar has reached parity with the euro. 

Published July 13 2022
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One-to-one. That’s the ratio the dollar and euro reached today, hitting parity for the first time in two decades. It’s the eye-catching event in an unprecedented year for the greenback, which has enjoyed sizable gains against the entire G10 community and the bulk of the emerging market complex, some to record highs. In the last few weeks, however, demand for the dollar has been unrelenting, sparing few currencies in its wake and putting it front and center on Wall and Main Street alike.  

To understand why the dollar is so strong, particularly versus the euro, you must first recall that foreign exchange is a relative game. Rarely is there is just one reason for the ebb and flow. Currency valuations are derived from multiple economic regimes operating at once and in varying degrees. However, there are three key pillars that constitute a currency’s value—interest rates, growth and safety—though they constantly change order of importance. In 2022, these have all been skewed in the dollar’s favor.

  • Interest rates Relative to its peers, the U.S. Federal Reserve clearly became the most hawkish central bank by the tail end of 2021. Backed by a growing interest rate advantage, this set the stage for the dollar’s first leg higher. At the time, the European Central Bank was still muddling around with its policy outlook. As a result, the euro began to steadily lose ground, but its decline was orderly and relatively modest at this point.
  • Growth The picture changed dramatically in early 2022 when Russia invaded Ukraine. Being near the epicenter of this conflict, and umbilically dependent on Russian gas, the euro began to suffer yet again on relative economic growth concerns. Moreover, the war fanned the already burning hot global inflationary pressures, which in turn provided more fodder for the Fed’s resolve to rein in pricing pressures at all costs. This development set the stage for the dollar’s third pillar, safety.
  • Safety As the Fed grew more hawkish, it catalyzed recessionary concerns on a global level and sent equity markets cascading lower. With traditional haven vehicles—namely government bonds—failing to provide a buffer from stock-market volatility, cash became an effective alternative. Traditionally, the dollar has always been a safe harbor instrument. With Europe facing a greater threat of stagflation, the currency became practically the only place to safely hide from elevated market volatility.

Today’s CPI print of 9.1% in June has intensified the situation, with the U.S. Dollar Index climbing. We are likely to see companies partly blaming its strength for poor earnings. While predicting the end of this surge is fruitless, it’s fair to say the pressures are not going away anytime soon.

Tags Monetary Policy . Fixed Income . Inflation . Interest Rates .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Consumer Price Index (CPI): A measure of inflation at the retail level.

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