Why the euro fell sharply, and the dollar strengthened

The devaluation of the European currency took place in the extremely unfortunate scenario of the energy crisis, but exporters from EU countries were extremely pleased with the first currency parity in 20 years.

It hasn’t happened in 20 years! The last time the euro and dollar equality, in other words, the 1: 1 exchange rate, was fixed in the autumn of 2002. Since then, the single European currency has continued to be worth more than US currency.

So, in 2008, when the financial crisis was erupting in the United States, for 1 euro they gave 1 dollar and almost 60 US cents, then the quotes fluctuated in the range of 1.30-1.50 over several years. , and in recent years they have estimated at the 1 .15-1.25 level.

War in Ukraine – the main reason for the weakness of the euro currency?

In the current 2022, a pair of the two major reserve currencies on the planet entered with a rate of 1.14, however, after the start of a large -scale war between Russia and Ukraine, the euro began to quickly become cheaper since the end of February. On July 8, for the first time in two decades, both currencies were almost equal in price, on July 11 the situation was repeated.

On July 12, equality was fixed, then the strengthening of the US currency could continue.

There is already a precedent: from the spring of 2000 to the autumn of 2002, first non-cash, and then the cash euro was worth less than $ 1, moreover, the exchange rate fell to the level of 0.85- 0.86 for two years in a row and sometimes even less than 0, 83.

Seeing the rapid depreciation of the euro in recent months, one can say that the Russian invasion was the main reason for the devaluation of the European currency: international investors withdrew their assets in dollars since a large-scale war was going on right in Europe, the European Union announced unprecedented sanctions against the Russian Federation, broke Russia’s traditional economic ties and faced an energy and, more importantly, the gas crisis that threatens the recession of EU countries.

The foreign exchange market is driven by central banks and government bond yields

However, if you look at the chart of quotes of the euro-dollar currency pair for a slightly longer period, you can clearly see that the gradual decline began in the first half of 2021, when the rate was even higher at 1.22 .

The reason for this trend is the expectations of global financial market participants that growing global inflation due to the consequences of the pandemic will force the US Federal Reserve System (FRS) to raise interest rates sooner, faster and more radical than the European The Central Bank (ECB) is ready to do.

And the increase in the base rates of central banks is leading to an increase in the yield of government bonds. The United States, with its large national debt, issues large numbers of such securities, and they are considered the most reliable investment assets in the world.

While the Fed has pursued a policy of “super cheap money” with almost zero base rate in recent years, U.S. government bonds have low yields and are not very attractive to investors. Therefore, many of them, in search of more profitable assets, convert dollars into other currencies.

The prospect of a rate hike has caused the influx of capital back into the dollar gap, a process that has intensified and accelerated since the fall of 2021 when it became clear that, due to accelerating inflation, the US base rate needs to be raised more drastically than could have been imagined a year ago.

The US Federal Reserve has raised its base rate sharply while the ECB waits

And it happened: in March 2022, the first increase since 2018 reached 0.25 percentage points, in May the rate increased by 0.5 percentage points, the sharpest in 22 years, and on June 15, it rose immediately by The Fed set the base rate at 0 .75 pp, which it has not done since 1994. And in the coming months, it will continue this course, as the ECB will only start to move away from zero interest in July, apparently with small step 0.25 percentage points.

This continued increase in the difference in interest rates and, accordingly, in the yield of government bonds between America and Europe became the main reason for the depreciation of the euro and strengthening of the dollar, and the war with Ukraine and the its consequences for the European economy have further fueled this trend.

“It is the Fed that is now setting the tone for the money market,” Michael Heise, chief economist at German investment firm HQ Trust, said in an interview with DW.

The fact that we are talking about the strengthening of the American currency is also confirmed by the fact that its rate has grown significantly in relation not only to the European, but also, for example, to the Japanese monetary unit. On July 11, the yen fell against the dollar to its lowest level in 24 years, Reuters reported.

In addition, in recent weeks there has been a lot of talk about an economic crisis looming over the US and EU countries. “Recession fears have risen in Europe,” German Commerzbank said in a new financial report. And in such cases, many international and especially American investors generally prefer to keep their money in the United States.

A strong dollar is not beneficial at all in the US

In addition, at some point in the foreign exchange market, a large number of stock speculators became more active, who decided to play for the collapse of the euro and push it at least to the sign mark of 1: 1. Those who entered this game on time are now clearly the winners.

And who else benefits from the devaluation of the euro and a significant strengthening of the dollar? The answer is: the United States, but this is partly true. Russia’s very popular formula “the stronger the money, the stronger the country” is far from universal and quite far from the realities of the modern global economy.

The high exchange rate of the national currency is beneficial for countries dependent on the import of large numbers of goods. From this point, the high dollar exchange rate is really beneficial for the United States, as it reduces the cost of products imported from Europe, China, Japan and other countries in the world and thus helps to fight inflation, which is currently almost the main macroeconomic problem of the United States.

At the same time, foreign products, which are becoming cheaper because of the hard dollar, are hurting American commodity producers themselves. In addition, the very high exchange rate of the national currency hurts the interests of American exporters, because it makes their products more expensive in the global market and thus reduces the global competition of cars, computers, microchips. , food and other Made in USA products. And they’re starting to lose ground, for example, in cars made in the eurozone, or semiconductors from Asia.

In short, the excessive strength of the dollar undermines the years of efforts of several Washington administrations to both equalize the country’s excessively upside-down trade balance (the U.S. imports more than it does. its exports) and boost American industrial production.

Accordingly, the low euro exchange rate is highly beneficial for German, French, Italian and other European exporters. However, with a big caveat: they must make their products in their homeland or in the European Union and use only European ingredients.

“If they buy shares outside the EU, the benefit is likely to be lost,” Sonja Marten, a foreign exchange analyst at German DZ-Bank, explained to DW.

The same, he continues, applies particularly to energy-intensive European industries, since oil, coal or liquefied gas are traded for dollars on world markets. From this point of view, the devaluation of the euro has now occurred at an unfavorable moment for the European Union. The EU is faced with a shortage and very high energy costs, and now, due to a record low in two decades, the euro exchange rate will become more expensive.

Source: Russian Service DW

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