Why It's 'Now or Never' for Euro-Dollar Parity

Political risks abound.

A Deep Dive Into Global Currency Markets

With the victory of President-elect Donald Trump rejuvenating the so-called divergence trade, calls for the euro to sink to parity versus the U.S. dollar are swelling.

One of Goldman Sachs Group Inc.'s top trade ideas for 2017, for example, entails euro-dollar uniformity being reached over the next 12 months. But such forecasts for an equal value of the euro relative to the dollar have historically been, on the surface, largely a case of price moves driving the narrative.

This time, however, it's "now or never" for euro-dollar parity, according to a team from Societe Generale SA.

Price fuels narrative
Source: Bloomberg

While the strength of the greenback — fueled by hopes of fiscal stimulus spurring faster growth and a swifter path higher for interest rates — has been the main story in foreign exchange markets since the election, "it is the threat of political tail risk and splintering of Europe" that could push the euro to reach parity against the dollar for the first time since 2002, writes Strategist Kenneth Broux.

The bank's house call is for the euro-dollar exchange rate, which the team notes is testing the bottom of its range for the third time since the start of 2015, to reach parity in the first quarter of 2017.

EURUSD Curncy (EUR-USD X-RATE) L 2016-11-22 06-18-36
Source: Bloomberg

The strategists say the widening of the spread between Italian and German government bond yields — a proxy for political fragmentation in the currency union — amid a continuation of the Federal Reserve's tightening cycle, sets the stage for the pair to reach its lowest levels in over 14 years.

"As we countdown towards the Italian referendum on Dec. 4, one can draw the obvious parallel with the current EUR/USD fluctuations and those in first quarter of 2013 when Italy's center-left won the general election in February and the Five Star Movement beat Mario Monti’s centrist coalition to third place," writes Broux. "In the three weeks before that Italian election (Feb. 24), EUR/USD dropped 3.3 percent from 1.3660 to 1.3194. It went on to weaken another 3.2 percent to 1.2772 in the four weeks that followed the results as Buoni del Tesoro Poliennali/Bund spreads widened."

While the spread blowout in 2012 did also look to hurt the currency, to add a cautionary note, this dynamic hasn't always been the primary driver of this pair.

EURUSD Curncy (EUR-USD X-RATE) L 2016-11-22 06-21-50
Source: Bloomberg

Meanwhile, Kit Juckes, the bank's global strategist, is looking ahead to another election — the French presidential, where the first round of voting is due to take place on April 23 — as key for the currency.

"My bet in market terms would be that the euro hits its low right up close to the election, possibly on the day of the election," he said during an interview on Bloomberg TV.

There's a "danger" National Front leader Marine Le Pen has the highest vote total after the first round, which would likely put markets on edge although she would not be expected to ultimately prevail, according to Juckes.

"My assumption and confidence is going to need a drink the day before that second vote," he quipped.

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