Eur/usd: The euro has now moved into the green against the dollar for the whole of 2024

(BFM Bourse) – The eurozone currency has been rising against the greenback since January 1, driven by expectations of rate cuts by the US Federal Reserve. Bank of America estimates that the euro could reach $1.12 by the end of the year.

The euro has made a nice comeback against the dollar in the space of a few weeks. In the first part of 2024, the eurozone currency suffered against the greenback, undermined by a slowdown in the economy in the monetary union and by a more flexible monetary policy on the part of the European Central Bank (ECB).

The Eurozone institution began to lower its key rates in June, while the American Federal Reserve (Fed) has not yet started its rate reduction cycle.

Recall that lower interest rates in a region theoretically attract less capital, which weighs on the demand for the local currency of that same region.

Between January and the end of June, the euro lost 3% against the dollar, a fairly clear movement on the foreign exchange market where variations are very contained due to its immense liquidity (7,500 billion dollars of exchanges per day).

But the situation has reversed since July. While it was trading below $1.07 at the end of June, the euro is currently trading above $1.11. The eurozone currency has gained 4% against the dollar in a few weeks, with an acceleration in particular from the beginning of August.

A dollar in pain

The euro also reached its highest level of the year against the dollar on Wednesday morning, according to data from investing.com at $1.1133, before falling back afterwards. And over the whole of 2024, the euro is now moving in the green against the American currency (+0.8%), the switch having taken place on Monday, still according to investing.com.

“The eurodollar pair has reached a new high in 2024, raising the question of whether the foreign exchange market is on the cusp of a broad-based and sustained decline in the US dollar,” UBS said in a note published on Wednesday.

This rebound of the euro against the dollar is explained, in fact, above all by the bout of weakness of the greenback since the beginning of August. The dollar index DXY, compiled by the Wall Street Journal and which measures the performance of the dollar against a basket of major currencies, has fallen by more than 2% since the beginning of August 1.

The dollar’s decline was triggered by poor US economic statistics in late July and early August. In particular, the US employment report, which showed job creation significantly lower than expected in July, and an unemployment rate that was moderate in absolute terms (4.3%) but at its highest since late 2021.

The jobs report sent panic through the stock markets earlier this month. Investors began anticipating major rate cuts from the Fed. Which obviously weighed on the dollar.

Expectations of rate cuts

Other US economic indicators have since helped global stock markets erase a large part of their losses. But investors continue to anticipate more significant Fed rate cuts than previously.

“The US dollar was lower this week as equity markets continued to recover from the shock of early August, while expectations for Fed rate cuts were largely maintained,” UBS noted on Wednesday. According to the CME Group’s Fedwatch tool, the market is currently pricing in a 100 basis point (1 percentage point) rate cut from the US central bank by the end of December. In July, market participants were only expecting 50 basis points.

“The US economy and interest rates are moving closer to the club of global lows, which is blowing a tailwind on the eurodollar,” explained Stephen Innes of Spi Asset Management in mid-August.

Upside potential?

Other factors may play a role, in addition to expectations about monetary policy and macroeconomics. The “carry trade”, for example. This market mechanism consists of borrowing funds in a country where interest rates are low to place them in a country where they are higher, and thus playing on the differences in the remuneration of the funds.

For a long time, investors played the “carry trade” by borrowing yen, Japan being one of the few countries to have maintained very low rates in 2022 and 2023, to place their funds in dollars or in emerging countries. But the increase in rates by the Bank of Japan at the end of July, coupled with expectations of rate cuts by the Fed, led investors to suddenly unwind their positions, and thus sell dollars (or emerging country currencies) to buy yen. This is what explained the surge in the yen at the beginning of August and, by ripple, the fall in Japanese stock markets.

According to Citi Bank, quoted Tuesday by Bloomberg, hedge funds have now started to do “carry trade” by borrowing dollars (rather than yen) to then place their funds in emerging markets. This could also penalize the dollar at present.

Looking ahead, can the euro continue its rise against the dollar? Bank of America is counting on the euro reaching $1.12 at the end of the year, slightly higher than its current level ($1.11). UBS is more cautious, judging that the “fair value” of the pair is around $1.095. The eurodollar seems “at this stage to be exceeding its economic fundamentals,” warns the Swiss bank. This means that the market is anticipating either some weakness in activity in the United States “or some optimism in Europe,” the bank continues.

UBS believes that the speech that Fed Chairman Jerome Powell will give on Friday at the Jackson Hole symposium could turn out to be less accommodative than investors expect. This could push the dollar up.

Julien Marion – ©2024 BFM Bourse