Is the Euro Bullishness Set to Continue into 2023?

In the second week of January this year, some data came out showing inflation in the US had continued to slow, so forex traders anticipated a speedy (dovish) change in Fed policy, which made the USD less appealing. The euro gained 1.6% against the dollar that week, marking its best level in nine months, leaving the EUR/USD forex pair at 1.08. This was a “remarkable comeback”, wrote Bloomberg, because it was only in November last year that the Euro dropped below parity with the dollar.

“Parity talks dominated forex debates in 2022, but it may be a matter of time before $1.20 calls emerge”, commented Audrey Childe-Freeman of Bloomberg Intelligence. After a series of 75 basis point (b.p.) hikes in 2022, the US Federal Reserve was expected to deal out a weaker 25 b.p. hike in February 2023, and to call it quits for the year after reaching only 60 b.p.

As to the European central Bank (ECB), it “has taken on the baton of being the more hawkish central bank”, in the words of Goldman Sachs’ Kamakshya Trivedi, and was expected to accumulate 140 b.p. in hikes in total for the year. The bullish feeling surrounding the euro was also due to the renewed positivity felt about the European economy, looking towards a fresh year, with natural gas prices more under control and China opening itself up after strict Covid protocols, which could steady supply chains.

The Powerhouse of Europe

Germany has been struggling to overcome skyrocketing energy prices, red-hot inflation, and supply chain problems since its emergence from Covid restrictions in 2021. Russia’s invasion of Ukraine, last year, magnified those problems considerably. Natural gas cost as much as $374 dollars per megawatt hour in August 2022, which signified a giant year-over-year increase of 1,000%.

However, two weeks into January 2023, European gas prices had been tamed by a massive 81% since that time. Concerted efforts to fill up gas storehouses and mild winter weather combined to generate this relief. As to consumer prices, they had slowed down from a pace of 10.4% in October (the highest in over seven decades) to only 8.6% by mid-January.

“The German economy has been more resilient than initially expected”, said Jan-Christopher Scherer of DIW Berlin early in the new year, because GDP managed to grow by 1.9% in 2022. In addition, manufacturing production picked up 0.2% in November last year, compared with the previous month’s 0.4% loss.

No Recession

Despite the progress made in the area of inflation, “Interest rates still have to rise significantly at a steady pace”, said Isabel Schnabel of the ECB in January. “Inflation will not subside by itself”, she added. The sturdiness of the euro economy supported her case that further hawkishness was needed. For instance, the ECB anticipate “very strong” wage growth this year.

Confirming positive feelings about the euro economy, Goldman Sachs withdrew their assessment that a recession was due to set in. Rather, as of January, they predicted GDP growth of 0.6% for the year, as compared with their previous projection of a 0.1% shrinkage.

“We also look for core inflation to slow due to cooling goods prices but see continued upward pressure on services inflation due to rising labour costs”, said Goldman.

The Bears

In the first 11 days of the year, Europe’s Stoxx 600 index gained as much as 5% amid all this bullishness, but some voices were more cautious. Euro bears pointed out Russia’s assault on Ukraine could accelerate, leading to another surge in energy prices, which could hinder growth. Also, in the event inflation heats up again in the US, with the economy continuing to strengthen, the Fed could stay hawkish and the US dollar could get another push upwards, making for a headwind for the euro.

Peeking Ahead

However, in the opinion of JPMorgan, the persistently hawkish attitude of the ECB will prop up the euro. And Deutsche Bank’s George Saravelos believes “The pieces are falling into place for a more sustained downturn in the dollar”. Other analysts believe that the more gas prices drop, the better news it will be for the euro.

In forex trading early in the second week of January, the dollar index (which gauges the USD against six other currency partners), fell 1.15% as traders rediscovered their appetite for risk.