Investors dash into the US dollar

The value of the US dollar has soared as investors pile in. The euro has hit parity, while the Japanese yen and the Swedish krona have fared even worse.

Recession in the eurozone is priced in,” say analysts at Japanese banking giant Mizuho. On Tuesday the euro slumped to parity with the US dollar – the lowest the euro has traded against the US currency since 2002. The selloff followed growing concern that the shutdown of the Nord Stream 1 gas pipeline to Germany for annual maintenance could turn into a more permanent closure. 

“The ECB [European Central Bank] is fiddling while the currency burns,” Neil Wilson of Markets.com told Julia Kollewe and Graeme Wearden in The Guardian. “Inflation above 8% and interest rates remain negative … it’s madness.” 

The euro’s slump could be a foretaste of what is to come if a Russian gas cut does materialise, say Lynn Thomasson and Farah Elbahrawy on Bloomberg. Economists at UBS think that the single currency could hit €0.90 to the dollar in that scenario, with corporate earnings falling by more than 15% and a 20%-plus drop in the Stoxx 600 index of pan-European stocks. German equities are already feeling the chill after tumbling 11% since June. Shares in gas giant Uniper, which is seeking a government bailout, are down 77% this year.  

Considering the circumstances – “the worst geopolitical crisis in Europe since the World War II” – the euro isn’t holding up all that badly, says Ambrose Evans-Pritchard in The Daily Telegraph. This is not so much a story of euro weakness as of the dollar’s strength against nearly all other big currencies. 

Note that the Japanese yen and the Swedish krona have fared even worse against the greenback this year. The dollar index, which tracks the US dollar‘s value against a basket of six major trading partners’ currencies, “has gone mad as the US Federal Reserve engages in frenetic triple-decker rate rises, belatedly scrambling to contain the inflationary blow-off of its own monetary creation, and to rein in the greatest fiscal expansion since Roosevelt’s New Deal”. 

Economic logic

The dollar’s rally is a matter of “economic logic”, says James Mackintosh in The Wall Street Journal. At a time of soaring global energy prices it makes sense for investors to head for America – a country that is “self-sufficient in energy” because of fracking – rather than Japan or Germany, which need to import oil and gas from elsewhere. At some point the current dollar bull trade will flame out, but “without a trigger – a peace deal in Ukraine [that] might restore cheap gas to Germany, or perhaps a dovish turn by the Fed – it is hard to see what could prompt the dollar to turn”. 

The dollar looks to be trading somewhere “between 10% and 20% north of fair value” at present, say Themistoklis Fiotakis and Sheryl Dong in a Barclays note. In the medium term that overvaluation should unwind, but don’t bet on it happening anytime soon. The dollar’s current strength rests on its role as a haven in uncertain times. Another “Covid-19 flare-up in China” or “more disruptions to the flow of Russian natural gas to Europe” could yet drive the greenback even higher.  

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