Mild Winter, Weaker US Dollar Support Euro Rally, as Analysts Abandon Bearish Outlook
Mild Winter, Weaker US Dollar Support Euro Rally, as Analysts Abandon Bearish Outlook

By Andrew Moran

Last year, the euro suffered a psychological barrier in the financial markets after it plummeted below parity with the U.S. dollar and cratered to its lowest level in about 20 years. From inflation to an energy crisis to recession fears, investors were ultra-bearish on the currency.

In the first few weeks of 2023, however, the euro has been building on the momentum that started in November. The euro has soared more than 10 percent in the last three months. Year to date, the euro has risen roughly 1 percent against the U.S. dollar, trading above €1.08.

According to Ipek Ozkardeskaya, a senior analyst at Swissquote Bank, the euro has been benefiting from a milder winter in Europe. This has eased the European energy crisis and diminished Russian President Vladimir Putin’s advantage over the region.

Should warmer-than-usual weather conditions persist, this could buy Europe time to continue building reserves and reducing reliance on Moscow. Moreover, if it does extend European nations another year, it could prevent a crisis if next year’s season turns out to be brutal.

In addition, a significant drop in natural gas prices has helped the situation. The natural gas market has tanked, falling nearly 23 percent since the beginning of the new year. Traders have been selling the so-called bridge fuel on mild winter weather in both North America and Europe.

“It’s a sure thing that the falling natural gas prices thanks to a soft but snowless winter in Europe make things look brighter for the Europeans from the energy crisis perspective,” Ozkardeskaya wrote in a note. “[E]very sunny day is a reason to accumulate euros because every ray of sunlight pushes the scenario of energy shortage away from the continent.”

The European Economy

The other factor has been better-than-expected economic data coming out of Europe.

In December, the annual inflation rate eased to 9.2 percent, down from 10.1 percent in November, according to EUROSTAT. But the core inflation rate, which excludes the volatile food and energy sectors, edged up to 5.2 percent.

Moreover, industrial production rose 1 percent in November (pdf), topping economists’ expectations of 0.5 percent. Retail sales jumped 0.8 percent in November, higher than the market estimate of 0.5 percent. The S&P Global Services and Composite Purchasing Managers’ Indexes (PMI) advanced to 49.8 and 49.3, respectively.

The European Central Bank (ECB) is weighing smaller rate hikes next month, effectively preventing a “Volcker shock,” says ECB governing council member Olli Rehn. This is a reference to former Federal Reserve Chair Paul Volcker, who raised the benchmark fed funds rate by double digits to fight inflation in the 1980s.

“By acting swiftly now, we should be able to avoid what is often called a ‘Volcker shock,’” wrote Rehn, adding that this does not, however, mean the ECB will turn dovish.

“Policy rates will still have to rise significantly to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2 percent medium-term target,” he said. “We will stay the course. Ceteris paribus [other things equal]—this means significant rate hikes in the following meetings. But the near term is shrouded in uncertainty, and we need to keep an open mind to adjust our policies if needed.”

Bloomberg survey of economists suggests that the central bank’s inflation-busting tightening campaign may end by the summer. The poll revealed that economists think interest rates will peak at 3.25 percent, and policymakers will cut rates to reverse a slowdown.

China’s reopening could also play an important role for both the European economy and the euro.

“While the euro ended 2022 on a positive note, 2023 has brought in more good news following China’s reopening and reduction in gas prices, raising hopes for Europe’s economic outlook,” Kunal Sawhney, CEO of equity research firm Kalkine Group, told The Epoch Times.

“Going by the trends, the euro may witness a better 2023, but it will all depend on how soon or whether the EU region can ward off the recession threats. Secondly, the Fed’s lower rate hike may also play a part in the euro’s favorable 2023.”

The US Dollar

The U.S. Dollar Index (DXY), which gauges the greenback against a basket of currencies, had an impressive 2022, rallying about 9 percent. But the index has been heading downward since November, falling nearly 10 percent. Year to date, the DXY has slumped close to 2 percent.

With expectations that the Federal Reserve is close to finishing its quantitative-tightening cycle, investors have fled the conventional safe-haven asset and turned modestly bullish on equities again. As a result, the leading stock market indexes have rebounded so far in January, led by the Nasdaq Composite Index’s 6 percent gain.

There is also growing optimism that global economic growth will be less anemic, supporting a broad array of other currencies, including the euro, the New Zealand dollar, and the Canadian dollar.

Looking ahead, Morgan Stanley analysts forecast that the U.S. Dollar Index will end the year at 98.00, down from its previous estimate of 104.00.

“Global growth is showing signs of buoyancy, macro and inflation uncertainty are waning, and the U.S. dollar is rapidly losing its carry advantage,” the bank’s currency strategists wrote in a note. “Within emerging markets, we see an approximately 5 percent total return until the end of the year. Outperformers include those that will likely be sensitive to a recovery in the Chinese economy, including those currencies which were underperformers in 2022 such as the Chilean peso.”

Where Is the Euro Heading?

A growing number of market analysts have modified their euro forecasts for the upcoming year amid the latest developments in the global financial markets.

ING analysts anticipate the euro/U.S. dollar exchange rate will rise to around 1.15 this year.

“Bearing in mind the importance of EUR/USD in driving FX [foreign exchange] trends globally, we no longer feel we can justify a sub-consensus profile over the coming years. Instead, we expect EUR/USD to work its way back to medium-term fair value, now around the 1.15 area,” wrote Chris Turner, ING’s global head of markets and regional head of research for the United  Kingdom and Central and Eastern Europe, in a note.

Deutsche Bank also projects the euro/dollar exchange rate climbing to 1.15 by the year’s end. German firm Heraeus believes it could strengthen to as high as 1.12 (pdf). Shaun Osborne, the chief foreign exchange strategist at Scotiabank, is “neutral/bullish.”

“Minor euro dips to the 1.08 area remain well-supported and price action appears to be carving out a short-term consolidation ahead of another push higher (bull flag/wedge pattern on the intraday chart),” he wrote in a note. “Momentum remains bullish, limiting euro losses and pointing to further gains. Support is 1.0775/00. Resistance (bull trigger) is 1.0870/75.”

The euro/dollar exchange rate rose 0.85 percent, to 1.0881 on Wednesday, up from 1.0790.

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