The euro slides towards dollar parity for the first time in 20 years

The euro is close to US dollar parity for the first time in two decades.

The European common currency has already slipped to a five-year low of nearly $1.03 after the greenback plummeted as a haven from market turmoil and the war in Ukraine.

That has prompted companies like HSBC Holdings and RBC Capital Markets to predict the two will reach parity in 2022.

Hedge funds are already betting on it.

They’ve amassed $7 billion in face value in options bets on parity in the past month alone, making them the most popular trade among those expecting the shared currency to continue falling.

“The euro itself is not an attractive currency at the moment,” said Francesco Pesole, currency strategist at ING Groep NV.

While the Dutch bank is keeping its official euro forecast at $1.05 for the next six months, Pesole admits dollar strength and market volatility make parity likely.

The euro’s plight is in large part a function of dollar strength, boosted as the Federal Reserve pushes for bigger rate hikes than its peers.

A fresh bout of global risk aversion that has swept stock and credit markets is only adding momentum to the move towards haven currencies.

The prospects for the European economy are also darkening.

An ongoing confrontation with Moscow over the continent’s natural gas supply has raised the prospect of a significant slowdown. The International Monetary Fund has lowered its growth forecast for the currency bloc to 2.8 percent for 2022.

The European Central Bank is thus walking a tightrope.

It must balance the need for tighter policies to tame record inflation against the prospect of economic damage that could ensue – particularly in some of the region’s most indebted member states, such as Italy.

While officials could potentially raise rates above zero before the end of the year, there are doubts about further hikes beyond that.

Investors will be watching speeches by ECB President Christine Lagarde in the coming days, as well as minutes from Thursday’s April bank meeting for more clues to think about.

Ms Lagarde has joined a crowd of policymakers signaling a rate hike as early as July.

“I think it’s politically difficult for many in the ECB to sound too dovish given that inflation probably hasn’t peaked yet,” said Peter McCallum, rates strategist at Mizuho International Plc. “Until we’re talking about 50 basis point hikes, it’s going to be difficult for many of the hawks to surprise the market right now.”

Any renewed sell-off in the euro, breaking the January 2017 low of $1.0341 – which was almost touched on both Thursday and Friday – could set the currency up for further losses.

With the region’s bonds also being dumped, the FX market could start factoring in euro-zone debt risk, according to strategists at HSBC Holdings Plc, including Dominic Bunning.

The spread between Italian and German yields – seen as a measure of risk – surpassed 200 basis points this month for the first time since the pandemic began.

Not all are negative.

Roberto Mialich, currency strategist at UniCredit SpA, expects the euro to rally back above $1.10 over the next year as the Fed’s rate-hiking cycle eases.

He sees a prolonged under-parity scenario only as a tail risk and only likely if growth in the eurozone collapses far more sharply than feared.

But as long as risky assets remain vulnerable, traditional havens like the dollar and yen will remain in vogue.

Russia’s war in Ukraine also remains a major headwind for the euro, particularly given the prospect of further gas supply disruptions.

“The euro has already faced more downward pressure than we anticipated, but we are finding it difficult to see a silver lining for the single currency at this point,” HSBC strategists wrote in a note, noting downgrades to growth forecasts and upgrades to Inflation. “It’s a foul cocktail that every currency tries to digest.”