Why isn't EURUSD below parity ... yet?

First, allow me to confess: I wasn’t expecting to write this article about EURUSD parity so soon.

When I published my Q3 outlook a couple of weeks ago, there was a 72.5% chance that EURUSD would hit 1.000 sometime this quarter.

Even with such elevated odds back then, I still thought this post-parity article wouldn’t be due for another few weeks.

But here we are.

 

Just as a quick reminder, the stunning decline in the world’s most popular currency pair, sinking to levels not seen in two decades, only underscores the divergence between the Eurozone and the US.

Here’s a recap from the June 30th article:

 

• The US economy’s healthier outlook relative to the Eurozone’s.
  After all, there’s still the Russia-Ukraine war raging off to the latter’s eastern borders.
  
  UPDATE: The June US nonfarm payrolls report released last Friday (July 8th) showed a still-resilient jobs market in the world's largest economy.

 

• The Fed’s plans for more incoming rate hikes appears to be less risky than the European Central Bank’s.
  The ECB is just only getting started, with two rate hikes slated for Q3.
  But markets fear that the incoming ECB hikes could inadvertently result in a sovereign debt crisis/fragmentation risks.
  
  UPDATE: Following yesterday’s higher-than-expected June US CPI print of 9.1% (its highest in over 40 years, since November 1981) markets have since begun to expect a historic 100 basis point hike by the Fed at its upcoming policy decision due July 27th.

 

But why hasn’t EURUSD broken below parity, yet?

One word: options.

At least that’s what market chatter is pointing to.

Without getting into the weeds of the derivatives market and what “options” are, the idea is that EURUSD is being “defended” at the psychologically-important 1.0000 mark by traders who are trying their utmost best from having to pay up on financial contracts if that proverbial line in the sand is crossed.

Also, it's tough to get a true headline figure as to how many billions worth of such options are in play at present, given the OTC (over the counter) nature of such contracts, yet they appear to have done the job so far in defending EURUSD parity over recent sessions, at least at the time of writing.

Still, such a defence can only be mounted for so long, given the fundamentally-driven selling pressures on the euro listed above.

 

So where to next for EURUSD?

If the 1.000 mark gives way, the next notable area of “defense” (i.e. support level) for EURUSD may arrive at 0.985, where another large chunk of options are congregated.

After that, euro bears could then send EURUSD towards the 0.950 mark.

 

Overall, given that there are multiple tranches of such options that may need to be defended between parity and 0.95, EURUSD may only see a grinding path towards lower levels, as opposed to the rapid declines from 1.15 to 1.000 that we’ve witnessed so far this year.

 

 

Still, EURUSD could be due for an immediate technical rebound, given that its 14-day relative strength index has gone below the 30 threshold that signals oversold conditions, .

 

Key event to look out for:

Beside the upcoming ECB and Fed respective July policy meetings due in the next couple of weeks, a major immediate risk for the euro pertains to the Nordstream 1 pipeline.

As noted in our Week Ahead article posted last Friday, this underwater gas pipeline from Russia to Germany is undergoing maintenance since last Monday through July 21st.

Markets fear that Russia may not restart this pipeline once maintenance has been completed.

Already, the likes of French Finance Minister Bruno Le Maire has warned of such a scenario, should Russia retaliate against sanctions, warning that the continent must prepare contingency plans (such as rationing).

Such an apocalyptic event would spark an energy crisis in Europe, and further darken its economic outlook by making a recession all but certain. That could even send EURUSD careening past 0.95!

 

If that happens, even a hawkish-sounding ECB later this month may not be able to significantly support the ailing bloc currency, barring direct interventions to support the currency like it did back in 2000 (when EURUSD fell to the depths of 0.823 in October 2020).

 

Can EURUSD stage a rebound?

From a fundamental perspective, hopes for a sustained rebound in the euro would have to be underpinned by:

• inflation having peaked and is turning over
• Russia-Ukraine war abating
• recovering Eurozone economy

It's hard imaging the above-mentioned factors materialising anytime soon. 

Hence, the euro is expected to maintain a downward bias against the US dollar (with the latter benefitting from its safe haven status and its higher yields versus Eurozone bond yields).

 

As things stand, here's what markets are forecasting for EURUSD:

• 0.985 = 75% chance of that level reached sometime this quarter (Q3 2022)
• 0.950 = 55% chance of that level reached within the next 12 months

 

EUR EURUSD Euro parity ECB European Central Bank Federal Reserve FOMC rate hikes Yields Ukraine crisis Russia-Ukraine war energy crisis US Dollar