Traders bet that the European Central Bank will hold off on raising interest rates because the economy is at risk of tipping into a recession, sending the euro to a 20-year low against the US dollar.
The common currency dropped to $1.0281, its lowest point since December 2002, by as much as 1.4 percent. Losses resulted from money markets continuing to trim ECB tightening bets as the region’s growth outlook dims and traders now focus on the possibility of gas shortages as Russia reduces supply.
Despite record inflation, the ECB is having trouble raising rates as quickly as the Fed due to the effects of the Ukraine war, which is widening the interest-rate gap. By year’s end, there is a 60% chance, up from 46% on Monday, that the currency will be equal to the dollar, according to Bloomberg’s options-pricing model.
According to Neil Jones, head of Mizuho’s FX sales to financial institutions, parity is only a matter of time.
Traders predict that the ECB will increase interest rates by 25 basis points later this month, beginning the first tightening cycle in ten years. In contrast, the Fed has already increased interest rates by 150 basis points, with the market anticipating a 75-basis-point increase at their July meeting.
The head of European FX Research at HSBC, Dominic Bunning, stated that it was difficult to find many things to like about the euro. There is also little support from higher yields because the ECB is sticking to its stance that we will only see a 25bp hike in July while others are hiking much faster and waiting for September to deliver a faster tightening.
The ECB is expected to deliver about 140 basis points this year, down from more than 190 basis points almost three weeks ago, according to money market traders. Following a string of dismal economic data last week, the repricing picked up speed, with traders again hedging their bets on Tuesday after the French services PMI was revised lower.
Due to the possibility of so-called fragmentation, in which economically fragile countries experience unjustified increases in borrowing costs as financial conditions tighten, investors have also become more cautious about the euro. At its policy meeting later this month, the ECB is anticipated to provide additional information about a new tool to support the debt of more vulnerable countries.
Three traders based in Europe claim that the lack of liquidity and selling in euro-Swiss franc contributed to the losses on Tuesday. The Swiss franc/euro exchange rate dropped as much as 0.9 percent to 0.99251, the lowest level since 2015.
The US holiday has prevented the FX market from returning to full liquidity, according to Jones of Mizuho. “Any given trade size is probably going to have a bigger effect on market movement.
