Majority of FX Traders See Euro-Dollar Parity in Survey as Stagflation Threat Rises

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(Bloomberg) — Foreign-exchange traders are set to bludgeon the euro anew as the war in Ukraine and the supply-chain crisis ramp up stagflation risk — driving the single currency to parity versus the dollar for the first time in nearly two decades.

In the view of 60% of respondents to the latest MLIV Pulse survey, the euro will eventually end up level with the greenback, with a small majority of more than 400 participants betting it will then recover to $1.15. It traded at about $1.05 on Friday, near its weakest since early 2017.

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Yet it’s a close call. Some 48% of those polled, who include economists and portfolio managers, project fresh losses to $0.95 — a notably more bearish outlook than Wall Street investment banks.

MLIV readers’ concerns underscore the European Central Bank’s policy headache as it seeks to cool rampant price pressures without killing off the business cycle, with 40% of respondents fearing a recession in the region more than inflation and the same proportion fretting over stagflation.

With the common-currency bloc’s proximity to the Russia-Ukraine conflict and dependence on cross-border trade, Europe is at the epicenter of global concern over rising prices and slowing economic growth. The euro area grew just 0.2% in the first quarter, as Italy contracted, France flat-lined and expansion in Spain slowed. Factory output and new orders have slumped and business confidence is evaporating.

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As the European Union’s dispute rages with Russia over gas payments, there’s a lack of consensus among survey respondents as to which side is set to suffer more. While 51% said the Kremlin would ultimately fare worse, 49% cited Europe as the principal loser.

When asked what would be the best trade to position for a possible recession this year, the most popular answer was to short the euro, followed by exposure to energy, via stocks or commodities. Going long bunds and cash came next, followed by gold and the dollar.

“If Ukraine gets worse, I would assume that Europe goes into recession,” JPMorgan Chase & Co. CEO Jamie Dimon told Bloomberg TV on May 4. “It may take a couple of quarters, but I would assume that.”

Economists tracked by Bloomberg have cut their 2022 eurozone growth forecast to 2.8% from 4.2% at the start of the year. Yet the risk of a recession is rising after Russia halted the flow of gas to Poland and Bulgaria. Businesses and consumers in Europe are facing a squeeze as prices rise, while China extending lockdowns blights the global growth outlook.

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There is huge uncertainty about the outlook for the region, as there is for the outcome of the war, Societe Generale SA CEO Frederic Oudea told Bloomberg TV on May 6. “Our central scenario, the central scenario of our economist, is more of a soft landing of GDP than a recession,” Oudea said. 

The median currency prediction of professional forecasters is for the euro to rally to $1.12 by year-end, with no bank surveyed by Bloomberg currently predicting parity. ABN Amro Bank NV did briefly make the case in March, though revised its call higher a few weeks later. Nomura Holdings Inc. previously warned a win for far-right candidate Marine Le Pen in France’s election could drive the currency to parity. 

Citigroup Inc. strategists recently recommended three-month euro-dollar parity puts, while the options markets imply a roughly 35% chance of that happening over the next six months.

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The euro’s weakness has been partly predicated on dollar strength, but now that Federal Reserve Chair Jerome Powell has downplayed the prospect of a 75-basis-point hike, the U.S. currency may start to look overbought. Meanwhile, moves in currency-hedging costs may soon make it more appealing for Japanese investors to own bunds over Treasuries, supporting the single currency. 

So while the dollar’s interest-rate premium threatens to widen, foreign exchange is about expectations. And there remains a bull case for the euro to rebound this year: U.S. monetary-policy tightening will eventually prove insufficient to boost the dollar further — just as the ECB potentially begins to hike rates as soon as July. All that may buoy the single currency, while leveraged funds are also cutting bearish bets. 

If this bullish road map comes to pass, it would vindicate the 20% of respondents who see the euro reaching parity first rather than the $1.10 level — and then rebounding to $1.15 instead of falling further.

For more markets analysis, see the MLIV blog. For previous surveys, and to subscribe, see NI MLIVPULSE.

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