EUR/USD price forecast amid dropping to parity

2022 has not been kind to EUR/USD bulls. The exchange rate just touched parity today for the first time in 20 years, and the sentiment remains bearish.

Despite the European Central Bank (ECB)’s efforts, the common currency moved in a bearish trend since the trading year started. 1.14 proved to be strong resistance, and on its way down, the currency pair formed only bearish patterns (i.e., pennant, descending triangle).

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Parity is always a psychological level.

A currency pair reflects the value of one currency in terms of another, and at parity, the two currencies are equal. But currencies move based on the economic differences between the economies they represent and the interest rate differential of the two central banks.

Both variables indicate more EUR/USD downside.

US economy is in a much better shape than the Euro area economy

Let’s start with the two economies – the United States and the Euro area economy. These are the two largest economies in the world, but the gap between them keeps widening.

After Russia invaded Ukraine in February this year, the euro kept dropping. An armed conflict on the outskirts of Europe weighs on sentiment and economic performance, as seen in the following data.

For instance, the Euro area largest economy, Germany, posted a trade deficit. Employment is not at levels seen in the United States, but inflation is somewhat similar in the two economies.

Therefore, while the data out of the United States remains robust (as shown by the June NFP report released last Friday), there are more signs of an upcoming recession in the Euro area.

And the worry is that the winter months will have a strong, negative impact on the European economies due to the energy dependence on Russia. The US economy has no such issues and is in a better position to fight a recession, should one come.

The two central banks move at different speeds in this cycle

For a currency pair, the actions of a central bank and the monetary policy are key drivers. In the case of the EUR/USD exchange rate, the Federal Reserve has raised the rates well above the zero level, while the ECB is yet to raise them.

Moreover, the expected interest rate hikes from the Fed and the ECB will cause the interest rate differential to widen further. Hence, any bounce in the EUR/USD exchange rate should be interpreted as just that – a bounce. Therefore, further downside is not only possible but plausible.