For the first time in twenty years, the Euro has reached parity with the Dollar. The war in Ukraine and the resulting disruption of energy supply, combined with already high inflation and a slowdown in the economy, have seen the Euro slide to levels not seen since the common currency took its first steps. Although the headlines are alarming, Moneyfarm is still not convinced that significant action needs to be taken on its portfolios and believes that the movement could even benefit investors. Risks to the Euro The Eurozone faces a long list of problems. Inflation (8.6% annualized in June) is at its highest since the launch of the single currency, business and consumer confidence is falling. While some of these problems can be attributed to the difficulty of reviving the economy after the Covid-induced closure, the conflict in Ukraine and the rupture of relations with Russia have poured oil (now very expensive) on the fire. Europe is very dependent on Russia on the energy front and this could lead to the "winter of our discontent" in Europe, with rising energy prices reverberating consumers, further increasing inflation fears and ultimately maintaining high bearish pressure on the Euro. A falling Euro also signals the growing lack of confidence in European economic strength and the European project as a whole. In this sense, not only have growth expectations for the bloc been steadily revised downwards since the beginning of the year, but the AGGRESSIVE STANCE HAS PUSHED UP YIELD DIFFERENTIALS BETWEEN "central" and "peripheral" countries, raising well-known fears about the single currency project and, therefore, the depreciation of the Euro against other currencies. The reasons for the strength of the Dollar On the other side of the Atlantic, the dollar reigns supreme: 2022 has so far been a year to forget for most assets, but the greenback is not one of them. The U.S. economy still has a very high level of employment, as well as higher confidence from consumers and businesses than other developed economies. The Federal Reserve this year began taking action to combat inflation. Given the relative economic strength of the UNITED States, the Fed has been able to raise rates rapidly (this year already rose from 0 – 0.25% to 1.50 – 1.75%). By way of comparison, the Bank of England (BoE) started raising rates before the Fed, but the weaker UK economy has forced the BoE on a more moderate path of hikes, while the ECB has yet to raise them, but has announced that it will start in July. Markets welcomed this Fed's decision and the US dollar strengthened this year. In short, investors seem to believe that the Federal Reserve is able to control inflation better than other major central banks, thus leading more investors to seek "shelter" in the dollar or dollar-denominated assets. While the dollar is likely to give up some of these firsts over the long term, other central banks will normalize interest rates and inflation will fall, for the time being investors are extending a vote of confidence to the Fed, but not to the ECB or the BoE. Moneyfarm's opinion Christine Lagarde faces a difficult path at the ECB. Although some countries, or even regions, show small signs of stabilising inflation, last month's data seem to indicate the need for a strong response from the ECB. However, higher interest rates are unlikely to be welcome in an already suffering economy, especially if the energy crisis worsens as winter approaches. Markets currently expect a recession in the Eurozone over the next 12 months with a higher probability than in the United States, although some of the main causes seem to soften their intensity. Some commodity prices have started to fall. Since these price decreases are passed on to consumer spending, this should begin to favor the fall in inflation. General negative sentiment, recession or not, should start to hit demand in Europe as well. If these factors improve, the outlook for inflation and Europe's economic health, or when the ECB begins to normalize monetary policy, the Euro could begin to recoup some of its losses. Although the United States is a major force in the global economy and makes up a large part of our portfolios, it is not the only currency to which our portfolios are exposed. The Euro has fallen against other currencies, but not so much. Once again demonstrating that the EUR/USD movement was caused as much by what is happening in the US as by what Europe is experiencing. Although the US economy is still showing signs of strength (if not overheating), a recession in 2023 is still possible and could lead to a reversal of the USD strength that we have seen so far in 2022. Finally, the impact of the fall in the Euro may not be negative for European investors. Any activity that Eurozone-based investors carry out abroad will have benefited from the weakness of the Euro: when it falls, their holdings abroad increase in value (all other things being equal). This means that the performance of any USD assets (i.e. US stocks or bonds) held by investors in Europe has benefited from the depreciation of the Euro. For the time being, given the highly uncertain macroeconomic environment and market volatility, we believe the dollar can still be a useful "safe haven" asset to hold. We will continue to monitor inflation data and the central bank narrative to assess whether some of the factors contributing to the appreciation of the dollar will begin to weaken. Economy
The analysis by Richard Flax, Chief Investment Officer, MoneyfarmFor the first time in twenty years, the Euro has reached parity with the Dollar. The war in Ukraine and the resulting disruption of energy supply, combined with already high inflation and a slowdown in the economy, have seen the Euro slide to levels not seen since the common currency took its first steps. Although the headlines are alarming, Moneyfarm is still not convinced that significant action needs to be taken on its portfolios and believes that the movement could even benefit investors. Risks to the Euro The Eurozone faces a long list of problems. Inflation (8.6% annualized in June) is at its highest since the launch of the single currency, business and consumer confidence is falling. While some of these problems can be attributed to the difficulty of reviving the economy after the Covid-induced closure, the conflict in Ukraine and the rupture of relations with Russia have poured oil (now very expensive) on the fire. Europe is very dependent on Russia on the energy front and this could lead to the "winter of our discontent" in Europe, with rising energy prices reverberating consumers, further increasing inflation fears and ultimately maintaining high bearish pressure on the Euro. A falling Euro also signals the growing lack of confidence in European economic strength and the European project as a whole. In this sense, not only have growth expectations for the bloc been steadily revised downwards since the beginning of the year, but the AGGRESSIVE STANCE HAS PUSHED UP YIELD DIFFERENTIALS BETWEEN "central" and "peripheral" countries, raising well-known fears about the single currency project and, therefore, the depreciation of the Euro against other currencies. The reasons for the strength of the Dollar On the other side of the Atlantic, the dollar reigns supreme: 2022 has so far been a year to forget for most assets, but the greenback is not one of them. The U.S. economy still has a very high level of employment, as well as higher confidence from consumers and businesses than other developed economies. The Federal Reserve this year began taking action to combat inflation. Given the relative economic strength of the UNITED States, the Fed has been able to raise rates rapidly (this year already rose from 0 – 0.25% to 1.50 – 1.75%). By way of comparison, the Bank of England (BoE) started raising rates before the Fed, but the weaker UK economy has forced the BoE on a more moderate path of hikes, while the ECB has yet to raise them, but has announced that it will start in July. Markets welcomed this Fed's decision and the US dollar strengthened this year. In short, investors seem to believe that the Federal Reserve is able to control inflation better than other major central banks, thus leading more investors to seek "shelter" in the dollar or dollar-denominated assets. While the dollar is likely to give up some of these firsts over the long term, other central banks will normalize interest rates and inflation will fall, for the time being investors are extending a vote of confidence to the Fed, but not to the ECB or the BoE. Moneyfarm's opinion Christine Lagarde faces a difficult path at the ECB. Although some countries, or even regions, show small signs of stabilising inflation, last month's data seem to indicate the need for a strong response from the ECB. However, higher interest rates are unlikely to be welcome in an already suffering economy, especially if the energy crisis worsens as winter approaches. Markets currently expect a recession in the Eurozone over the next 12 months with a higher probability than in the United States, although some of the main causes seem to soften their intensity. Some commodity prices have started to fall. Since these price decreases are passed on to consumer spending, this should begin to favor the fall in inflation. General negative sentiment, recession or not, should start to hit demand in Europe as well. If these factors improve, the outlook for inflation and Europe's economic health, or when the ECB begins to normalize monetary policy, the Euro could begin to recoup some of its losses. Although the United States is a major force in the global economy and makes up a large part of our portfolios, it is not the only currency to which our portfolios are exposed. The Euro has fallen against other currencies, but not so much. Once again demonstrating that the EUR/USD movement was caused as much by what is happening in the US as by what Europe is experiencing. Although the US economy is still showing signs of strength (if not overheating), a recession in 2023 is still possible and could lead to a reversal of the USD strength that we have seen so far in 2022. Finally, the impact of the fall in the Euro may not be negative for European investors. Any activity that Eurozone-based investors carry out abroad will have benefited from the weakness of the Euro: when it falls, their holdings abroad increase in value (all other things being equal). This means that the performance of any USD assets (i.e. US stocks or bonds) held by investors in Europe has benefited from the depreciation of the Euro. For the time being, given the highly uncertain macroeconomic environment and market volatility, we believe the dollar can still be a useful "safe haven" asset to hold. We will continue to monitor inflation data and the central bank narrative to assess whether some of the factors contributing to the appreciation of the dollar will begin to weaken. • 24 July 2022