The impending return of former President Donald Trump to the political arena has the currency market bracing for a significant event: the potential for parity between the US dollar and the euro. This scenario, where one euro equals one dollar, is anticipated by strategists at prominent financial institutions like Bank of New York Mellon Corp. and Mizuho, following Trump’s inauguration later this month.
Since late September, the euro has depreciated over 7% against the dollar, recently hitting a two-year low of $1.0226. Options markets currently price in a roughly 40% probability of the currency pair reaching parity this quarter, with a surge in trading activity for contracts targeting this level observed last week.
Market participants are keenly watching the aftermath of January 20th, Trump’s inauguration day, for potential triggers. Both BNY Mellon and Mizuho foresee Europe bearing the brunt of a potential trade war initiated by the returning president. Furthermore, diverging growth trajectories between Europe and the US could fuel dollar strength unseen in two decades, potentially pushing the euro to parity as early as this month.
“Parity is inevitable,” asserts Geoffrey Yu, senior strategist at BNY Mellon, who anticipates euro bearishness to peak around the Federal Reserve and European Central Bank meetings scheduled for late January. He adds, “We’re not far off, so it could happen very quickly.”
The euro and the dollar have traded at equal value only a few times since the euro’s inception in 1999. These instances often coincided with comparatively adverse economic conditions in Europe relative to the US. The most recent occurrence was in 2022, following Russia’s full-scale invasion of Ukraine, which triggered an energy crisis and recessionary fears in Europe.
While energy supply and security remain concerns, exemplified by the recent halt in Russian gas flow through Ukraine, Mizuho’s head of macro strategy for EMEA, Jordan Rochester, suggests that a surge in energy prices is unlikely to significantly impact European monetary policymakers given the current sluggish economic growth.
European export-oriented economies are currently grappling with the threat of US trade tariffs and the anticipation of aggressive interest rate cuts by the European Central Bank. This contrasts sharply with the Federal Reserve’s more cautious approach. Political instability within major European economies further exacerbates the pressure.
“Sentiment could not be worse,” remarks Antony Foster, head of G-10 FX spot trading at Nomura. He identifies January 20th as a potential catalyst for further euro weakness, particularly if Trump swiftly implements tariffs after taking office.
Despite a recent euro rebound amidst broader dollar weakness and reports of options traders abandoning parity bets, major banks like JPMorgan Chase & Co. maintain that parity remains achievable this quarter. Wells Fargo, however, posits a second-quarter timeframe as more likely.
According to Jane Foley, head of FX strategy at Rabobank, the outlook hinges on whether markets receive further confirmation of benign inflation trends, which could support a more aggressive pace of ECB rate cuts. Euro-area inflation accelerated last month, bolstering the ECB’s gradual approach to reducing interest rates.
The ECB is projected to lower its deposit rate to 2.75% at its upcoming meeting. Conversely, the Fed is expected to maintain rates within a 4.25% to 4.5% range, underscoring the widening divergence in monetary policy. BNY Mellon’s oversight of over $50 trillion in assets indicates the euro is currently the most underheld currency in two decades.
“How can anyone be bullish euro?” Nomura’s Foster queries.
The divergence in monetary policy between the Federal Reserve and the European Central Bank, coupled with potential trade tensions and political uncertainties, paints a challenging picture for the euro. As the market awaits Trump’s return to power, the possibility of euro-dollar parity looms large, signaling a potential shift in the global economic landscape.
