Euro Tumbles to 20-Year Low, Putting Parity With Dollar in Sight

(Bloomberg) — The euro slid to the lowest level against the US dollar in two decades as investors grappled with the prospect of an energy crisis that risks tipping the region into a recession.

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The common currency fell as much as 1.8% to $1.0235, its weakest level since December 2002, weighed down by the threat of gas shortages that could disrupt industrial activity across the region if Russia cuts off supplies. Money-market traders trimmed ECB tightening bets against the darkening backdrop, widening the interest-rate differential with the Federal Reserve.

The fallout has hampered the ECB’s ability to raise rates as fast as the Fed despite record inflation, knocking around 10% off the euro’s value from a peak around $1.15 this year. There is now a 60% chance the common currency extends its slide to parity versus the dollar by year-end, up from 46% on Monday, according to Bloomberg’s options-pricing model.

“Parity is just a matter of time,” said Neil Jones, head of FX sales to financial institutions at Mizuho. Strategists at HSBC Holdings Plc and Nomura International Plc also see the euro trading on par with the greenback this year.

Germany’s cabinet on Tuesday rushed through legislation allowing it to rescue struggling energy companies, in an effort to prevent the supply crunch from seeping into the broader economy. Russia, the region’s main supplier, has already cut flows to several European Union countries and curbed shipments along the main pipeline route to Germany, the bloc’s biggest economy.

“It is hard to find much positive to say about the EUR,” said Dominic Bunning, the head of European FX Research at HSBC. “There is also little support coming from higher yields.”

Traders are betting the ECB will kick off their first tightening cycle in a decade later this month with a 25 basis-point increase, and deliver around 135 basis points this year. That’s down from more than 190 basis points almost three weeks ago. The Fed in contrast has already raised rates by 150 basis points, with markets pricing in an 80% chance of a 75-basis-point hike at their July meeting.

The move lower in the euro is just a just a “warning sign” of what’s in store later this month if the Nord Stream 1 gas pipeline from Russia is shut off, according to Jordan Rochester, analyst at Nomura. “We have an even higher conviction that EUR/USD will breach parity towards 0.98 in August, with the risk of a non-linear move towards 0.95,” he added.

Investors have also been more cautious on the euro due to the risk of so-called fragmentation, when economically weaker nations see unwarranted spikes in borrowing costs as financial conditions tighten. The ECB is expected to deliver further details of a new tool to backstop more vulnerable countries’ debt at their policy meeting later this month.

The losses Tuesday were compounded by poor liquidity and selling in euro-Swiss franc, according to three Europe-based traders. The euro fell as much as 0.9% against the Swiss franc to 0.99248, the lowest level since 2015.

(Updates prices, adds Nomura comment in fourth and eighth paragraphs.)