Is the Euro Bullishness Set to Last Until 2023?

In the second week of January this year, certain data showed that inflation in the United States had continued to decline, thus forex speculators expected the Fed to alter policy quickly (dovish), making the USD less desirable. That week, the euro gained 1.6% versus the dollar, reaching its highest level in nine months, leaving the EUR/USD currency pair at 1.08. Bloomberg called this an “amazing turnaround,” noting that the Euro had just fallen below parity with the dollar in November of last year.

“Parity talks dominated forex debates in 2022, but it may be a matter of time before $1.20 calls emerge”, said Bloomberg Intelligence's Audrey Childe-Freeman. Following a succession of 75 basis point (b.p.) rise in 2022, the US Federal Reserve was predicted to deliver a lesser 25 b.p. boost in February 2023, before calling it quits for the year at just 60 b.p.

The European Central Bank (ECB) “has taken up the mantle of being the more hawkish central bank,” according to Goldman Sachs' Kamakshya Trivedi, and was projected to raise interest rates by 140 basis points this year. The optimistic sentiment around the euro was partly due to the newfound optimism felt about the European economy as we enter a new year, with natural gas costs more under control and China opening up following stringent Covid regulations, which might stabilize supply chains.

The European Powerhouse

Since its release from Covid constraints in 2021, Germany has struggled to address increasing energy costs, raging inflation, and supply chain issues. Russia's invasion of Ukraine last year exacerbated such issues significantly. Natural gas might cost up to $374 per megawatt hour in August 2022, representing a 1,000% rise year over year.

However, two weeks into January 2023, European gas prices have fallen by an astounding 81% since then. This respite was generated by a combination of concerted efforts to fill gas storage tanks and moderate winter weather. Consumer prices had fallen from 10.4% in October (the highest rate in over seven decades) to 8.6% by mid-January.

“The German economy has shown to be more robust than projected,” remarked Jan-Christopher Scherer of DIW Berlin early in the new year, citing GDP growth of 1.9% in 2022. Furthermore, manufacturing output increased by 0.2% in November of last year, after a 0.4% decline the previous month.

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There will be no recession.

Despite gains in inflation, “interest rates still need to increase considerably and steadily,” stated ECB spokesperson Isabel Schnabel in January. “Inflation will not go away on its own,” she continued. The strength of the eurozone economy bolstered her argument that more hawkishness was required. For example, the ECB predicts “quite substantial” wage growth this year.

Goldman Sachs removed their prediction of a eurozone recession, confirming optimistic emotions about the eurozone economy. Rather, as of January, they expected 0.6% GDP growth for the year, contrary to their earlier forecast of a 0.1% decline.

“We also expect core inflation to decline owing to cooling goods prices, but we expect services inflation to remain elevated due to increasing labor costs,” Goldman added.

The Packers

Despite all of this bullishness, Europe's Stoxx 600 index rose up to 5% in the first 11 days of the year, but other voices were more cautious. Euro bears warned that Russia's attack on Ukraine might escalate, causing another spike in energy costs that would stifle GDP. Also, if inflation rises again in the US as the economy continues to expand, the Fed may remain hawkish and the US currency may rise further, creating a headwind for the euro.

Looking Ahead

However, JPMorgan believes that the ECB's continually hawkish stance will support the euro. And Deutsche Bank's George Saravelos says “The components are fitting into place for a more persistent drop in the dollar”. Other economists feel that the lower gas prices go, the better for the euro.

The dollar index (which measures the US dollar against six other currencies) plummeted 1.15% in forex trading early in the second week of January as traders recovered their appetite for risk.

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