Euro/Dollar: How low can you go?

Government stimulation, Eurozone troubles and even China worries. Not a day goes by without speculation about how this will influence the Euro/Dollar exchange rate. The exchange rate is trading at $1.061, following a downward trend since 2014 and one might wonder where the bottom lies.

The exchange rate experiences the heaviest shocks if either the ECB or the FED has a press conference, but even mere speculation on implementations causes the exchange rate to react heavily as markets have trouble to make up their mind. A clue on whether the downward trend may continue can be found in the probabilities of central bank actions. A survey by The Economist finds that 92% of economists expect a rate hike in December. This still leaves some margin for the Euro/Dollar rate to drop even further. Of course, the exchange rate will also react to the actual amount of the rate hike, but overall, one might expect a drop in the exchange rate if the FED does indeed hike the rate.

And then there is the ECB. The ECB is thinking about extending and intensifying its Quantitative Easing (buying government bonds) and introducing a negative interest rate in December. Every day, the intensifying of QE becomes more probable which also pushes the Euro down. The realization of  the ECB plans could see the Euro drop sharply.

There remains some uncertainty about the underperforming European countries, which might cause trouble for the Eurozone as a whole. For example, a Grexit may cause other countries to leave the Eurozone as well, which harms Euro stability. This is another reason why European Central Bank stimulation is more likely than FED stimulation.

In effect, the stimuli by the FED creates a higher demand for dollars, while stimuli by the ECB creates Euro supply. These factors both drive the Euro/Dollar exchange rate down. As these stimuli are not yet implemented there is still some margin for the Euro/Dollar to go even lower. Since the probabilities, which are not 100%, are priced into the market, there will be some shock if new policy implementation will actually be announced and realized. The Euro/Dollar rate might well go below $1, even hitting $0.90.

December will see lots of action, one way or the other, from central banks. We expect the Euro/Dollar exchange rate to go even lower and we will probably see some downward shock within a month as a result of Central Bank policy making.