Societe Generale expects the euro to hit parity against the dollar for the first time in almost 15 years at the start of 2017 as political uncertainty in the single currency area begins to crystallise.
The euro has repeatedly fallen below the $1.06 mark in the past couple of weeks, something it hadn’t done in a year previously, and Societe Generale now expects it to drop further, hitting a bottom of $1.00 in the first quarter of 2017.
Parity between the euro and the dollar will be driven by two big catalysts: European politics, and a strengthening dollar following the expected rate hike by the US Federal Reserve in December.
The euro has dropped roughly 5.5% since Donald Trump’s shock victory. Investors fear that his win is going to strengthen populist sentiment globally, and particularly in Europe, where the likes of Marine Le Pen in France, and the Five Star Movement in Italy are gaining popularity.
Kit Juckes, one of Soc Gen’s currency strategists said in a note circulated on Tuesday: “Nervousness about the political outlook and potential for yet another populist surprise will keep the euro under pressure.”
Writing in a separate note, strategists Kenneth Broux, Carole Laulhere, and Santosh Ejanthkar, said Trump's victory pushed the euro to "levels only observed three times since early 2015."
The chart below illustrates those times:
The continued uncertainty surrounding the political picture - which Trump's victory has muddied even further - may be key in driving the euro lower, but the expected tightening from the Fed is also key. Market expectations currently put the chances of an interest rate hike at the Fed's December meeting at around 95%, and more hikes are forecast in the near future.
Broadly speaking, higher interest rates push a currency's value up in relation to others. This is because if interest rates are higher in the US than Europe, dollar-denominated investments in the US create higher returns. That, in turn means more people want dollars against the euro, with that demand pushing the currency higher.
Here's Societe Generale's analysis of why it's expecting parity:
"We expect EUR/USD to fall to a bottom of parity in Q1 2017 before rising back to 1.09 by the end of 2017. The forecast is based on two rate increase by the Fed next year, but this comes with the risk of more. Before the election of Trump we had anticipated a peak Fed funds rate of 1.25%-1.50%, but we now look for 1.75%-2.0%. For the ECB, our economists believe tapering will start in March with the objective of ending asset purchases in early 2018, market conditions permitting."
This isn't the first time a major bank has predicted euro-dollar parity in recent times, with Goldman Sachs forecasting something similar late last year. This didn't materialise, and the euro strengthened from $1.06 in late November 2015, to around $1.09 at the end of the year.
The euro is little moved against the dollar, down roughly 0.1% as of 12.10 p.m. GMT (7.10 a.m. ET). Here's the chart:
