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The Euro may reach parity with the Dollar in 2015 (english)

During 2014, the USD has been appreciating against the EUR. This affects all of us who work with China, especially if we are located in Europe. The chinese yuan is de facto tied to the USD (although slowly appreciating against it in a very controlled way), so when the USD appreciates against the EUR, the CNY also appreciates against the EUR, directly increasing the cost of imports from China for European companies.

In 2014 the USD has moved from 1.42 to 1.25 USD/EUR, increasing the cost of Chinese products for Europeans by more than 10%

So, what can we expect for 2015?

American economy is growing again, it’s at it best moment since the financial crisis of 2008. Unemployment is low too. Inflaton is under control but, with all the money americans have printed, and given the experience of 2004-2008 with low rates (thanks to Mr Greenspan), it’s unlikely that they will keep low interest rates for too long.

As soon as Americans begin increasing interest rates, a lot of money invested in emerging economies will go back to american markets. Most emerging economies are not performing so well anymore, why take the risk when you can get a decent yield with american financial products? This flow will put pressure on the USD to increase further.

On top of that, economy in the euro area is not good. Politicians have had a lot of time to take decisive action since Mr Draghi saved the euro with his “whatever it takes”, and they have done nothing. Structural problems are exactly the same as they were in 2008, and people in charge are the same (Mr Junker nomination clearly points that european politicians don’t care about what their citizens vote in european elections, but that’s another issue). On top of that, a proposed trade deal with America that would help a lot (especially with a strong USD) will probably not go ahead because of vested interests of some European countries. European economy is not growing and might go into deflation in 2015 if the situation does not change a lot.

Summarizing, in the short term, USA is going up, Europe is going down. Things might change, but in the short term investing in America will look more interesting that investing in emerging economies, and much much more interesting than investing in Europe. So, black swans not considered, logic says that the USD will continue appreciating and will probably reach parity with the Euro in 2015.

From the point of view of a European company that imports from China, that’s bad news. Today we are at 1.25 USD/EUR, what happens if we reach parity? Cost of imports increase by 20%. What happens if we reach 0.8 USD/EUR? Cost of imports increase by 35%. We are not talking science fiction, the USD/EUR was at 0.8 in years 2000 and 2001

 

As I say, there are many more possible situations that can change this scenario, for instance:

– Russia will become more and more aggressive now that sanctions are hurting and capital is flying.

– American stocks are overvalued (courtesy of the FED) and some big market movement downwards is quite possible, which usually creates unstability

– European leaders might agree to work together towards more european integration, improve European competitiveness and improve economy (hehe, just joking)

My bet is that the Chinese government will depreciate the RMB against the USD for the first time in 10 years. Europe is the first trading partner of China. If the USD increases too much, China will loose competitivity in Europe and they will loose sales, which might hurt China’s economy, especially now that the growth is not so strong. Chinese leaders might decide to unpeg from the USD and look for a middle way. For instance, if the USD appreciates by 20% against the EUR, they might decide to appreciate only a 10% against the Euro (in fact depreciating 10% against the USD). They would loose 10% competitivity with Europe, would gain 10% competitivity in the US and would have problems with the US congress because they would be “too competitive” in America. It’s a bold move with political consequences but we need to consider it. It will lower the price of chinese goods in USD, helping offset the increase in prices in EUR.

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EUR/RMB exchange rate 2004-2015

As we can see in above chart, this trend could have already begun. The chinese government stopped appreciating the RMB against the USD at the beginning of 2014. If the USD goes to parity and the chines government depreciates the RMB against the USD by 10%, the exchange rate would go back to the flatlands we got in 2008-2010, after the financial crises. That would decrease prices of chinese goods (in USD), partially offsetting the increase of pruces in euro due to the EUR/USD exchange rate.

The situation will probably not last for long. Taking into consideration that a big chunk of products that europeans consume come from China, the increase of import costs might finally help create a little inlation. That would be the perfect excuse for the ECB to raise rates, money flows will reverse and USD will go down again. But tis will take some time. While it lasts, the high USD will hurt european importers.

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