This article is written by Marcus Ashworth, a former chief market strategist for Haitong Securities in London and a Bloomberg opinion columnist covering European markets.
In recent weeks, economic indicators have continued to deteriorate, and the eurozone is suffering immensely. The EU's political, fiscal, and interest rate paths have exacerbated the euro's weakness, pushing its exchange rate close to parity with the dollar. Even Europe's largest asset management company, Amundi SA, has stated that the euro to dollar exchange rate could reach parity by the end of the year. Europe may not be facing a survival crisis, but it is undoubtedly in deep trouble.
The euro is being impacted by the strong U.S. economy, stock market, and dollar. Frustratingly, the euro seems to have lost control over its own fate, with its direction seemingly entirely dependent on the actions of elected President Trump. In stark contrast to Europe's stagnant growth, Atlanta Fed's GDPNow shows that U.S. GDP is expected to grow 2.6% in the fourth quarter—providing a favorable backdrop for further dollar gains.
The euro to dollar exchange rate has fallen to a two-year low. It is not the only currency that is weak against the dollar, but its performance is even worse than the pound, which also released poor economic data last Friday. Although the euro has not yet entered a free-fall zone, its predicament shows no signs of ending. Any rebound in the forex market is more likely to come from a slowdown in the dollar's rise rather than from the euro itself.
The political situation is chaotic, and Germany now faces the same dilemma as France. These two largest economies in Europe happen to be leading the economic downturn, with Germany's GDP growth for the third quarter revised down to just 0.1%. In November, the eurozone composite PMI fell from last month's 50 to 48.1, marking the fourth drop into contraction territory this year; this time, it seems difficult to return above the growth line. The eurozone manufacturing PMI has once again dropped to 45.2, indicating that the industry is clearly in recession; more worryingly, the services PMI fell from 51.6 in October to 49.2.
France and Italy are walking a tightrope, depending on how the European Commission deals with their collective severe overspending, which violates EU deficit rules. French Prime Minister Michel Barnier is struggling to pass a barely acceptable 2025 budget proposal in the National Assembly, as his revenue-raising proposals have failed to gain approval.
Barnier can bypass parliament, but if his government subsequently loses in a confidence vote, the entire political system could collapse. Brussels may have no choice but to bring him back to the negotiating table. Fiscal rules are a necessary condition for maintaining the entire euro system, even if it is very inconvenient to restrict government spending during economic downturns and falling tax revenues.
Germany's industrial dilemma is well known, but any future moves to relax domestic debt limits must be combined with a new economic pact for the eurozone. A flexible approach to rules has always been a hallmark of the EU in its tortuous development. The German Constitutional Court is a major obstacle to the ambitious plans proposed by former ECB President Mario Draghi in September. Hopes for a repeat implementation of the €800 billion ($840 billion) pandemic recovery plan may be dashed. However, realpolitik dictates that Brussels must act before it is too late.
This brings to mind the European Central Bank. President Lagarde called last Friday for eurozone member states to unite on the still non-existent capital markets union issue. However, a more serious signal from a more united council is that monetary policy cannot bear all the heavy economic measures; without corresponding fiscal efforts, rate cuts will be ineffective.
The futures market is beginning to anticipate more significant rate cuts, with expectations now shifting to an emergency cut of 50 basis points.
In a recent meeting, officials hinted that the December 12 meeting would lower the deposit rate by 25 basis points to 3%; Frederik Ducrozet, head of macro research at Pictet Wealth Management, stated this could be a policy mistake as it may cause the ECB to fall behind the curve.
The eurozone's October inflation data, released on November 29, may show an increase in nominal and core inflation indicators, which could prompt hawkish members of the ECB to oppose accelerating the pace of easing. The current view is that the neutral interest rate (the rate that neither stimulates nor hinders economic growth) is close to 2%, which happens to be the ECB's inflation target. But this is precisely why the euro is so weak and lacks support for the future—the so-called neutral rate in the eurozone is far lower than that of the U.S. or the UK.
Futures pricing indicates that by next summer, the ECB's deposit rate could drop to as low as 1.75%.
The lesson officials have learned from the pandemic is that a combination of fiscal and monetary stimulus can be very effective. This combination has supported the eurozone economy, but its prolonged duration has led to soaring inflation. Now the European Central Bank may be forced to cut rates more aggressively; however, to avoid a significant decline in the euro against the dollar, Brussels needs a fiscal Plan B—and quickly.
Currency pairs typically fluctuate around relative differences in interest rates; however, growth expectations are the true driving force. From this perspective, the euro is more likely to fall to and below parity with the dollar.
Article reposted from: Jinshi Data