On May 18, the euro dipped to 1.2162 dollars, its lowest level since April 17, 2006. However, even at this time the currency has been far above its critical level of 0.86 recorded on September 2000 and its long term fair value of 1.20. Looking further, even though the euro has recovered slightly since the third week of May, we are anticipating the downward trend to continue in the next few months. Indeed, European officials haven't managed yet to assure the markets about Euro Zone ability to contain fiscal crisis and guarantee the sustainability of its debt. So far, the EUR750 bn package of measures to stabilize bond issuance have failed to boost investors confidence. Also, the European Central Bank interventions in government bond markets as well as the re-opening of dollar swap lines between the G7 central banks haven't brought any substantial improvement in investor's sentiment towards Euro.
More importantly, the fluctuations in EUR/USD exchange rate have to do a lot with different growth and interest rate expectations for the United States and Euro Area. First, while the US economy grew by 2.5% from previous year in the first quarter of 2010, the European Union expanded only by 0.5%. And it is expected that fiscal tightening and structural reforms which are taking place in Europe will slow down its economic growth at least for a while. Second, steadily improving housing and labor market in the United States increased the possibility of an overnight interest rate hike within the next few months. That said, rate expectations for the Fed and the ECB could not be more different and we expect the EUR/USD to continue to fall during this year.
