Why is EURUSD still below parity… yet? :: InvestMacro

by ForexTime

First, let me admit: I was not expecting to be writing this article on EURUSD parity so soon.

When I post a file Q3 forecast two weeks agoThere was a 72.5% chance that EURUSD would hit 1.000 sometime this quarter.

Even with such high odds at the time, I still think this post parity article won’t be due for a few more weeks.

But here we are.

As a quick reminder, the astonishing decline in the world’s most popular currency pairs, which has fallen to levels not seen in two decades, only confirms the difference between the Eurozone and the US.

Here is a summary from the June 30th article:

  • The Fed’s plans for further rate hikes appear to be less risky than those of the European Central Bank.
    The European Central Bank has just started, and it is scheduled to raise interest rates twice in the third quarter.
    But markets fear that the upcoming ECB increases may inadvertently lead to a sovereign debt crisis/fragmentation risk.

    Update: After US CPI reading for June came in higher than expected yesterday at 9.1% (highest level in more than 40 years, since November 1981) markets have since started to expect a historic 100 basis point rise by the Fed In the next policy decision due in July. 27.

But why did the EURUSD not break? less Parity, yet?

One word: options.

At least that’s what the market talk indicates.

Without getting into the weeds of the derivatives market and what ‘options’ are, the idea is that EURUSD is being ‘defended’ at the psychologically significant 1.0000 mark by traders doing their best from having to pay on financial contracts if that line that is crossed is crossed. The proverb is in the sand.

Also, it’s hard to get a real headline figure on how many billions of these options there are at the moment, given the OTC (over-the-counter) nature of such contracts, yet they seem to have done the job so far in defending the EURUSD parity. During recent sessions, at least at the time of writing.

However, such can only be defended for so long, given the selling pressure primarily driven on the Euro mentioned above.

So where next for the EURUSD?

If the 1.000 mark declines, the next noticeable “defense” area (i.e. support level) for the EURUSD may reach 0.985, where another large portion of options are accumulating.

After that, the bears could send the EURUSD towards the 0.950 mark.

In general, since there are multiple slices of these options that may need to be defended between parity and 0.95, EURUSD may only see milling path Towards lower levels, in contrast to the rapid declines of 1.15 to 1.000 that we have seen so far this year.

However, EURUSD may be due to an immediate technical recovery, given that the 14-day RSI has fallen below the 30 threshold indicating oversold conditions.

Key event to look for:

Besides the upcoming policy meetings of the European Central Bank and the Federal Reserve scheduled for the next two weeks, the main immediate risk to the euro relates to Nordstream 1 pipeline.

As noted on our site Next week’s article This underwater gas pipeline from Russia to Germany was deployed last Friday, and has been under maintenance since last Monday until July 21.

Markets fear that Russia may not restart this pipeline once maintenance is complete.

Already, the likes of French Finance Minister Bruno Le Maire have warned against such a scenario, if Russia retaliates against sanctions, warning that the continent should prepare contingency plans (such as rationing).

Such a shocking event would spark an energy crisis in Europe, and darken its economic prospects by making a recession almost certain. This could lead to EURUSD surpassing 0.95!

If that happens, even a hawkish-looking European Central Bank later this month may not be able to significantly support the troubled bloc’s currency, except Direct currency support interventions as they did in 2000 (When EURUSD fell to depths of 0.823 in October 2020).

Can the EURUSD pair rebound?

From a fundamental perspective, hopes for a sustained recovery in the euro should be supported by:

  • Inflation has reached its peak
  • The decline of the war between Russia and Ukraine
  • Eurozone economic recovery

It’s hard to picture the above factors materializing anytime soon.

Thus, the Euro is expected to maintain a bearish bias against the US Dollar (with the latter benefiting from its safe haven status and higher yields against Eurozone bond yields).

As it stands, here’s what the markets are expecting for the EURUSD pair:

  • 0.985 = 75% chance of this level reaching sometime this quarter (Q3 2022)
  • 0.950 = 55% chance of reaching that level in the next 12 months

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