Market News

BY Naomi Tajitsu and Nick Bartlett

(Bloomberg) -- The euro rose to its strongest this year versus the dollar as the wall of cash headed for Europe’s defense industry prompts analysts to drop forecasts for parity between the two currencies.

Goldman Sachs Group Inc., MUFG and TD have abandoned predictions that one euro will buy one dollar this year. The European currency has surged about 4% from a two-year low just one month ago, and Deutsche Bank AG says the likelihood of a fall below parity has reduced.

Europe’s leaders have accelerated steps to unlock hundreds of billions of euros of military spending, and the extra cash is seen boosting the economy — keeping interest rates and the currency higher as a result. European Commission President Ursula von der Leyen announced nearly €800 billion ($841 billion) of potential funding on Tuesday.

“The current wave of spending in Europe, while negative from a debt sustainability point of view, will lead to more cohesion and solidarity, keeping European spreads contained and strengthening the euro,” said Ales Koutny, head of international rates at Vanguard Asset Management Ltd.

Parity would only be a topic of conversation in the event of “a full-blown trade war,” he said.

Hopes for more defense spending in Europe are offsetting the lingering risk of US tariffs, which strategists had said could trigger the euro’s drop to parity. The euro was trading 0.7% stronger at $1.0556 on Tuesday, its highest level since December, despite US President Donald Trump’s decision to enact levies on China, Mexico and Canada.

There’s been a historic shift in European fiscal policy in recent weeks as Trump made clear Europe can’t rely on the US for defense, negotiated directly with Russia to end the war in Ukraine, and fell out publicly with Volodymyr Zelenskiy.

According to Deutsche Bank, the fact that Germany is preparing bigger defense spending will be a particular shield against parity for the euro.

For Goldman, tariffs are still a “pillar” of their currency outlook. At the same time, “they could be a little less impactful than what we had initially anticipated,” strategists led by Kamakshya Trivedi wrote in a note.

Goldman now sees the euro trading at $1.01 in six months, weaker than current levels, but stronger than its previous call for $0.97.

Less Bearish

In the options market, risk reversals in the euro-dollar pair over the next six to 12 months indicated traders have turned the least bearish on the common currency since November. The softening sentiment comes as investors slash bets for a weaker euro since the start of the year, the latest CFTC data show, after those wagers hit their highest level in more than three years in December.

What our strategists are saying...

“With Europe likely to line up defense spending on a scale not imaginable in recent years, the prospect of stickier yields and the boost to the economy from ramped-up fiscal loosening will keep the euro bid in the weeks to come.”

—Ven Ram, Cross-Assets Strategist, Dubai. Read MLIV post here

At MUFG, tariffs on European goods look more likely in the second quarter than in the first. The bank now sees the euro trading around $1.02 by the end of the month from a previous call for a drop to $0.99.

Most strategists agree that the euro stands to take a big hit if Washington slaps aggressive tariffs on European goods. But while downside risks to the currency remain, the Japanese bank believes they have “certainly diminished.”

According to Derek Halpenny, head of FX research at MUFG, diverging interest-rate trajectories in Europe and the US as the European economy picks up, will burnish the appeal of the common currency.

“Predicting Trump’s actions is fraught with risks, but as the year unfolds we believe cyclical forces will come to the fore and the US economy will slow while the euro-zone economy can stabilize,” he wrote in a note.

The euro could strengthen to $1.08 by year end, he predicted.