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The euro is set to record its eighth consecutive week of losses against the dollar as the widening gap between a struggling eurozone economy and a more robust US economy prompts investors to sell the currency. Since mid-July, the euro has lost over 5%, currently trading at $1.07. The decline reflects growing doubts about whether the European Central Bank will raise interest rates at its meeting next week, as the eurozone economy shows signs of heading towards a downturn. In contrast, industrial production in Germany, the eurozone’s traditionally strong economy, fell for the third consecutive month in July. This contrasts with unexpected falls in US jobless claims, highlighting the resilience of the US labour market and potentially encouraging the Federal Reserve to maintain current high interest rates. This makes the appeal of the dollar stronger.
ING’s Chris Turner said, “The US data is relentless and it’s coming at a time when the European manufacturing sector is very weak. There are doubts about whether the ECB can squeeze in one final hike.” Derivatives markets currently imply there is around a 35% chance of the ECB raising rates from 3.75% to 4% on 14 September, which has fallen due to a series of weak economic data recently. Additionally, eurozone second-quarter growth was revised down from 0.3% to 0.1%, and business surveys indicate a further slowdown in August.
Dirk Schumacher, a former ECB staffer and current economist at Natixis, predicted the ECB would choose a “hawkish pause” where rates are not increased, but it is made clear that inflation is still a concern and tightening measures can be resumed. Schumacher said, “That would keep the market more on its toes, rather than a hike, which investors would instantly assume was the last.” With signs of a looming recession in Europe, some investors believe that it will be difficult for the ECB to raise borrowing costs further, even if it deems it necessary to bring inflation down to its 2% target.
Tomasz Wieladek, Chief European Economist at T Rowe Price, said “[A further rate rise] could actually be counterproductive because if they hike into a recession it means they will have to cut much more going forward. This is a serious risk and I think they might have built themselves a trap, recent data has been unashamedly dovish.” A weaker euro could complicate the ECB’s task of fighting inflation by driving up the cost of imports, such as energy and food products. The rise in oil prices following Saudi Arabia and Russia’s extension of production cuts this week has also added to inflationary pressures, with Brent crude reaching its highest level since November at over $90 a barrel.
Some investors are now suggesting that the euro area is experiencing stagflation – high inflation combined with stagnating economic growth. Michael Metcalfe, Head of Macro Strategy at State Street Global Markets, said, “With eurozone inflation still above average and growth well below, it’s clear that by most definitions the eurozone is suffering from stagflation.” In contrast, investors expect the dollar to continue its rebound from weakness earlier this year, as the strong US economy provides little incentive for the country to cut interest rates in the near future, a move which Federal Reserve Chair Jay Powell has consistently pushed back on.
Greg Peters, Co-Chief Investment Officer of PGIM Fixed Income, believes there has been too much negativity surrounding the dollar and predicts that it will continue to reassert itself. He said, “The central driver of rates continues to be growth.” Investors now expect that the Fed has finished raising interest rates, but they are now betting that rate cuts will not begin until the middle of next year. Swaps markets previously priced in rate cuts before the end of 2018, but that has since changed.