The relationship between the US dollar and the euro has been on a rollercoaster journey in recent months. After years of sinking, the euro appeared to reach a level of stability, and some were saying that the euro could potentially be dubbed as a “safe haven”, stealing the title from the US dollar.
Despite contending with the removal of the EUR/CHF floor in January, and the launch of the ECB’s asset purchase scheme in March, the euro rebounded from its lowest exchange rate in 12 years, when faced with the Grexit. Surprisingly, even with such political unrest surrounding Greece and the EU, the euro was seen as this “safe haven”. Against the backdrop of China’s economic slowdown, it was the US dollar’s turn to prove volatile, whilst the euro enjoyed a period of stability.
However, whilst the euro dropped significantly just recently due to Mario Draghi’s expansion of the quantitative easing programme, the rules of the game have significantly changed, and we are seeing a change in this once typical strong dollar, weak euro relationship.
China has been at the forefront of the media spotlight in recent months, with news of the economic slowdown hitting the headlines. Whilst the full extent of the slowdown isn’t clear, no one believes the ‘official’ data that China is producing, and ultimately, no one can be completely sure of how this will affect the global economy.
What we have seen, though, is that every time the markets tumble over fear of China, the dollar falls, and the euro appreciates. It seems as though the dollar is more sensitive to China’s economic problems, as opposed to the euro. This could be down to the previously positive outlook of the US economy, which has subsequently deteriorated over threat of impact from China.
The Federal Reserve originally had two rate hikes planned for this year, but neither have materialised. Awaiting to assess the ‘real’ impact of China’s slowdown, the hikes have been postponed on both occasions. However, this has increased investors’ concerns over the strength of the US economy.
The American economy and monetary policy
Whilst the US has previously enjoyed a period of strong growth, it looks as though the fear of a global slowdown is affecting the economy. Although GDP grew at a rate of 3.7% in the second quarter, job creation has since waned, and doubts about the strength of the American economy are rising.
As we’ve already touched upon, the Fed has also postponed interest rate hikes on two occasions now. Awaiting the outcome of China, it is unlikely that there will be ideal market conditions for a rate hike, meaning that it probably won’t even happen this year.
Despite the threat of a Grexit earlier in the year, there has been an unexpected turnaround and there is now less doubt surrounding the EU, with China replacing Greece as the cause for concern. Whilst Greece’s serious debt problem is far from being solved, it may not return with the strength that it did a few months ago.
To add to this prosperity, the economic situation is also improving in other euro-troubled zones. Italy and Spain, for example, are seeing a gradual recovery and it is looking as though Greece could finally receive the debt relief that it requires.
However, whilst the euro has seen a turnaround, it’s important to remember that this could change at any moment – and it did. A particularly strong euro isn’t necessarily always ideal. It increases the prices of Eurozone products and exports to foreign markets, and lowers inflation pressures when consumer prices are at near-zero levels. The ECB was determined to boost the Eurozone economy, so Draghi took the option to expand the QE programme. But the real question is to ask whether this will be enough to convince investors that the euro has lost its title of the “safe haven” currency.
Mario Draghi’s announcement also gave strength to the US dollar as the euro depreciated. Whilst this almost seems a backtrack on previous trends, businesses should be cautious to not become complacent. A slight appreciation of the US dollar doesn’t mean that this will be the way forever, nor should a sudden depreciation of the euro be taken as a trend that will stay.
We have undoubtedly seen a shift in the EUR/USD trend lately, and if the recent ECB decision has taught us anything, it is that nothing is certain. Amid these changes, businesses must remember that the balance is always short lived with currency, and the best way forward in this situation is always to protect your margins against a sudden increase in volatility.