Sudden strength of the euro against the dollar astonishes

The dollar is weakening. Still, it's too early for obituaries on the greenback, DWS says. (Image: Dean Photography)

Foreign exchange markets have been caught on the wrong foot by the decisive action of european policymakers. Despite the dollar's current period of weakness, experts at DWS expect the greenback to strengthen again over the longer term.

Since mid-may, the dollar has fallen by more than 8% against the euro. Historically, he said, this is not an unusual movement. Nevertheless, DWS experts were surprised by the sudden strength of the euro against the dollar.

Forecasting exchange rates is rightly considered a difficult business. Since two currency areas are always involved, the relative development is decisive. So roughly how the price level in one country changes relative to the price level in another. This is known as purchasing power parity. In a highly simplified form, this could involve comparing the prices of fast food products available in many different countries. Foreign trade figures or the relative movement of interest rates in different countries can also provide clues.

Ingredients for dollar correction

However, none of these approaches explains the strength of the euro in recent months. "Rather, the market was probably caught on the wrong foot by the decisive action of european policymakers," says DWS. Thanks to drastic measures to contain the pandemic, the number of infections in europe fell significantly in may. In the U.S., on the other hand, there was another sharp rise in june and july. In addition, germany gave up its resistance to a transfer union and, together with france, set up an EU reconstruction fund. This is historic in every respect: funds amounting to 750bn. Euros were split into 390bn. Euro grants and 360 bn. Euro low-interest loans to benefit the countries most affected by the pandemic.

"If we still consider the positioning in the currency futures market, where many market participants had positioned themselves for a weaker euro, the ingredients for a correction in the dollar were in place," explains DWS. But with the appreciation of the euro, the positioning has also shifted. Currently, as many investors speculate on a continuation of the dollar weakness as last in 2018, as the "chart of the week" of DWS shows.

Investors speculate on continuation of dollar weakness

"We remain rather skeptical. Covid contagion figures are currently rising again in europe, while they are falling in the USA. The election campaign in the USA has begun and the pendulum has already swung very strongly in favor of the democrats. From a market perspective, this could bode ill for developments such as tax increases," DWS said. However, trump's election in november is by no means certain yet. The EU recovery fund is unlikely to be increased, but experts expect further fiscal measures in the U.S. "In this respect, the obituaries on the dollar seem to us to be very premature," says stefanie holtze-jen, chief currency strategist at DWS. Because after a temporary phase of weakness, the specialist expects rather again with a firmer greenback.