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US Dollar in Difficulty Against Euro

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Written By: Adrian Moore – Forex Focus

Since the beginning of 2017, the euro keeps strengthening against the US dollar, with around a 10-percent increase between January 2 and June 29, from $1.04 per euro to more than $1.144 per euro.

Many factors are pushing the euro up, and simultaneously other reasons are pushing the dollar down against the euro.

On the European side, investors are waiting for the progressive decrease of the monetary measures of the European Central Bank (ECB).

These actions have been largely announced and are going on as expected. After a first decrease in April of the ECB repurchase program to a monthly level of €60 billion, the ECB should decide in the third quarter if it continues on, or, to the contrary, if it reduces its program of repurchase for 2018. This decision can be seen as heavily influencing the euro against the dollar, as since the beginning of April, when one dollar was still exchanged at 1.07 euros, the euro has kept climbing. And beyond the benefits of the expected reduction of monetary stimuli, signs of improvement in the economic conditions of the euro area have also appeared.

Indeed, Mario Draghi, president of the ECB, was optimistic during his recent speeches about the economic outlook for the euro area. According to him, the risks of deflation have dissipated and the revival of a slight consumer-price inflation can be seen. Recently, for instance, German inflation was announced at +1.5 percent, above the +1.3 percent expected by experts. Spanish inflation was also above expectation at +1.6 percent.

The markets seem to believe in a growing demand and a possible acceleration of the German economy, Europe’s leading economy. That could bring a small increase in salaries and put the economy back on a good trend. What is to be noted is the optimistic interpretation from the markets of the European Central Bank’s recent presentation in Lisbon, Portugal. Mario Draghi said that the ECB would “adjust its monetary policy only gradually, with the euro area still in need of ‘considerable’ monetary support, despite a recovery in the economy and more sustained inflation”. It seems that investors did not hear the middle of the sentence about the still considerable need of monetary support. But as Ipek Ozkardeskaya, an analyst at London Capital Group, commented, “The euro’s uptrend is also, and perhaps mostly, due to the depreciation of the dollar”.

Indeed, on the American side, the US dollar has a number of reasons to weaken.  

The paradox is that it is the same kind of monetary-tightening measures expected from the US Board of Governors of the Federal Reserve System (the Fed) that is leading to the weakness of the US dollar. For specialists, the fact that all major central banks are approaching monetary tightening is reducing the leadership capacity of the Fed. The sharp rise in US rates should be attracting investors, but with other major central banks also talking about tightening, investors are looking for opportunities elsewhere.

In addition to these monetary-policy considerations, US economic figures lately have not brought the expected good news. The International Monetary Fund (IMF) revised its 2017 gross domestic product (GDP) growth forecast for the US downward from 2.3 to 2.1 percent. The Washington-based international financial institution stated that President Donald Trump’s administration “intends a wide-ranging overhaul of policies, although a fully articulated policy plan has yet to emerge”. In addition, Federal Bank of St. Louis’ president, James Bullard, said that the current level of the Fed’s rate is appropriate and signalled that the recent inflation data was surprising on the downside.

Indeed, US inflation has slowed noticeably in recent months, to below 2 percent. The annual consumer price index (CPI) in February was running at 2.8 percent year over year, but by May it had fallen to 1.9 percent year over year. Similarly, the Fed’s preferred inflation measure—the personal consumption expenditure (PCE) price index—dropped from 2.1 percent in February to 1.7 percent year over year in April.

In a context of too weak growth and downside inflation surprises, specialists are now questioning the Fed’s intention to further raise interest rates. The Fed increased rates to between 1 and 1.25 percent in June, and the US central bank confirmed that “this year” it would start to shrink its $4.5 trillion balance sheet. With average hourly earnings and retail sales falling, questions about the real health of the US economy are naturally emerging, and further rises in interest rates could be judged too early. Beyond all of these recently published US figures, the capacity of the Trump Administration to put in place its announced fiscal and economic reforms, as well as promised investments in public infrastructure, to achieve the promised 3 percent growth in GDP seems to be moving further away.

The coming summer months are historically characterized by lower volumes and higher volatility on currency markets. However, the lasting disappointed expectations surrounding Trump’s reforms, as well as small but good surprises in Europe’s figures, could turn investors back to the euro market this summer.


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