What happened: The euro collapsed to around $1.03 and is down more than 8% year-to-date against the US dollar. It is now trading at its lowest level since late 2002.
Most analysts believe the bottom is not yet in. Forecasts are circulating that it could even reach parity, where one dollar can be exchanged for one euro.
“I’m bearish on the euro until I see a headline that tells me global growth will pick up sharply,” Nomura strategist Jordan Rochester told me. He believes that the euro will reach parity by the end of August.
Breakdown: What’s good for American tourists is hard for European companies, who need to buy energy, raw materials and components at dollar prices. Soaring import costs could push prices further up in the 19 countries that use the euro, where annual inflation rose to a record high of 8.6% in June.
What is triggering the sell-off of the euro, the world’s second most used currency? Analysts point to a few factors.
The first is the economic outlook. Fears of a recession are increasing worldwide. But Europe’s proximity to the war in Ukraine and its historic dependence on Russia for its energy needs have made it more vulnerable than the United States.
Natural gas prices in Europe are at their highest level since March. Russia has halted gas supplies to Europe and the major Nord Stream pipeline is about to undergo maintenance. Energy workers in Norway have just gone on strike and are threatening further supply shortages.
“We have an impending winter crisis for the euro zone and I expect energy prices to remain very high,” Rochester said.
The euro tends to perform poorly when investor risk appetite declines.
Another issue is trade. Germany just reported a rare monthly trade deficit, a sign that high energy prices are weighing on manufacturers in Europe’s export powerhouse. A weaker euro will then be necessary to make the bloc’s exports more competitive.
Europe is also lagging behind the United States in raising interest rates, although the European Central Bank expects to start raising interest rates this month. That means investors are more likely to park their money in the United States, where they can earn better returns.
With interest rates rising, there are concerns that bond markets in countries with high debt burdens such as Italy and Greece could come under pressure. The ECB has said it will work to prevent what it calls “fragmentation,” but it remains a risk traders are watching closely.
Customers “are very concerned about all things European,” said Kit Juckes, strategist at Societe Generale, on Tuesday. “Germany’s trade data fell poorly yesterday and there is widespread sentiment that the current account surplus will be hit by energy prices. Add to that concerns about fragmentation and fears that the global economy is turning south, and it’s hard to get even a little optimistic about the euro.”
It’s Bezos vs. the White House vs. inflation
Decades of inflation are catching the attention of the White House, which is trying to reassure Americans that it takes price hikes seriously. That has increased the finger pointing towards corporate America, which the Biden administration says is making the problem worse.
“My message to the companies that operate gas stations and set prices at the pump is simple: This is a time of war and global danger,” President Joe Biden tweeted over the holiday weekend. “Reduce the price you charge at the pump to reflect the cost you pay for the product. And do it now.”
That sparked an outcry from Amazon founder Jeff Bezos, who became increasingly open on Twitter.
“Ouch. Inflation is far too important an issue for the White House to continue making such statements,” he tweeted in response. “It’s either outright misdirection or a deep misunderstanding of fundamental market dynamics.”
Veteran venture capitalist Bill Gurley also jumped into the fray. He said he “totally” agrees with Bezos, citing “the last three hundred years of economic research and understanding.”
The White House rejected the criticism.
“Oil prices have fallen about $15 over the past month, but prices at the pump are little down. This is not ‘fundamental market dynamics’. It’s a market that’s failing the American consumer,” press secretary Karine Jean-Pierre said on Twitter. “But I think it’s not surprising that you think oil and gas companies using market power to make record-breaking profits at the expense of the American people is how our economy should work.”
Check the numbers: US oil prices have fallen over the past month as recession fears have come to the fore. West Texas Intermediate futures, the benchmark, were last trading at around $108.50 a barrel, compared to over $118.50 a month ago. That $10 difference is smaller than the White House figure.
It is true, however, that overwhelming relief has not occurred at the pump. The average price for a gallon of regular gasoline is $4.80. A month ago it was $4.85 compared to $3.13 a year ago.
Is this the result of price gouging? Maybe in selected cases. But the biggest drivers of fuel prices right now are increased demand and limited supply, particularly of gas and diesel. That’s the result of disruptions from the pandemic, the war in Ukraine, and the arrival of the summer driving season in the northern hemisphere. A lack of investment in refining capacity also exacerbates the problem.
$380 oil? JPMorgan sees a scenario where that’s possible
Global oil prices surged above $139 a barrel shortly after Russia invaded Ukraine. They last traded below $113. But strategists at JPMorgan Chase see a possible scenario where “stratospheric” $380 crude could be on the cards, making recent gains paltry by comparison.
Step back: Last week, G7 leaders agreed to draft a plan to cap Russian oil prices. This would allow the country’s discounted kegs to continue entering the market, but would reduce Moscow’s revenue.
Details are still being recorded. But in theory, customers like China and India would only pay $50 to $60 a barrel to get insurance from Western companies on their cargo.
That would dampen revenue for the Kremlin, which has estimated the price of its export barrels at over $80 by the end of 2022.
But the JPMorgan team, including strategist Natasha Kaneva, warns that Russia could retaliate by deliberately curbing oil production, as it is doing with natural gas. That would send prices through the roof. If production is cut by 3 million barrels a day, the bank predicts prices could rise to $190 a barrel. In a “worst-case scenario” of a 5 million barrels-per-day cut, prices could reach $380.
“If the geopolitical situation warrants it, it now seems more likely, in our view, that export cuts could be used as a lever/political tool,” Kaneva and colleagues wrote this month.
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US factory orders for May will be released at 10am ET.
Coming tomorrow: Investors will comb through the minutes of the June Federal Reserve meeting.