Summary
- Despite the euro’s 10% depreciation versus the U.S. dollar so far this year (as of mid-August), the break of parity between the two currencies is what has caught investors’ attention.
- As uncertainty rises and investors seek liquidity, the dollar tends to perform well.
- Potential cuts in cheap Russian gas supply represent a fundamental change in trade balance dynamics.
- As we approach winter and power prices in the eurozone increase, we believe the euro/USD relationship has likely not yet found a bottom.
By Maximilian Korell
Euro weakness versus the U.S. dollar has generated excitement in the markets, but how much worse could things get?
Despite the euro’s 10% depreciation versus the U.S. dollar so far this year (as of mid-August), the break of parity between the two currencies is what has caught investors’ attention. How did we get here? Market dynamics have changed dramatically from last year: A roaring reopening and “transitory” inflation were exchanged for a widening U.S.-EU yield gap, front-loaded rate-hike cycles, stagflation risks, prospects of an imminent energy crisis and a major war in Europe.
From an investment perspective, at least in the short term, such a change appears to be only good for one currency: the U.S. dollar. As uncertainty rises and investors seek liquidity, the dollar tends to perform well. Hence, in hindsight, it’s no surprise that euro-U.S dollar started to depreciate from 1.1450. However, breaking parity only became possible with the help of a fundamental change to the trade balance.
What used to support the single European currency during similar environments was its massive trade balance surplus. A weaker currency, in moderation, increases export competitiveness—a bedrock of the eurozone’s economic performance. However, potential cuts in cheap Russian gas supply represent a fundamental change in trade balance dynamics.
Today, Europe is ramping up imports of alternative energy sources—mainly liquified natural gas ((LNG))—in order to avoid blackouts next winter. Outside of this risk, we believe investors should focus on the new energy import dynamics. While Russian gas was settled in euros, LNG trades in U.S. dollars. This has helped the eurozone trade balance turn negative, negating the advantage of a weakening currency for the exporting sector. Moreover, eurozone PPI was running at 35.8% year-over-year at the end of June, easily offsetting the effects of higher foreign income being converted into euros.
Importantly, we don’t expect the eurozone to face major difficulties with energy supply this winter. Rather, it will cost much more to keep electricity production stable. This, in turn, could make the recent shift in the eurozone’s trade balance persist for as long as LNG supplies do not significantly drop in price.
What does this mean for investors? As we approach winter and power prices in the eurozone increase, we believe the euro/USD relationship has likely not yet found a bottom. However, with gas storage levels approaching 100%, a stable supply of LNG and the ECB increasing the deposit rate, we do not anticipate significant depreciation for the euro from these levels.
This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice. This material is general in nature and is not directed to any category of investors and should not be regarded as individualized, a recommendation, investment advice or a suggestion to engage in or refrain from any investment-related course of action. Investment decisions and the appropriateness of this material should be made based on an investor's individual objectives and circumstances and in consultation with his or her advisors. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. The firm, its employees and advisory accounts may hold positions of any companies discussed. Any views or opinions expressed may not reflect those of the firm as a whole. Neuberger Berman products and services may not be available in all jurisdictions or to all client types. This material may include estimates, outlooks, projections and other “forward-looking statements.” Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed.
Investing entails risks, including possible loss of principal. Investments in hedge funds and private equity are speculative and involve a higher degree of risk than more traditional investments. Investments in hedge funds and private equity are intended for sophisticated investors only. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results.
This material is being issued on a limited basis through various global subsidiaries and affiliates of Neuberger Berman Group LLC. Please visit www.nb.com/disclosure-global-communications for the specific entities and jurisdictional limitations and restrictions.
The “Neuberger Berman” name and logo are registered service marks of Neuberger Berman Group LLC.
© 2009-2022 Neuberger Berman Group LLC. All rights reserved.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
For further details see:
Assessing The Euro's Move Below Parity