FXE: The Future For The Euro Versus The Dollar Relationship

The euro is the world’s newest currency. In January 1999, the E.U. launched the euro, with coins and banknotes replacing marks, francs, lira, pesetas, escudos, drachma, and other European currencies on January 1, 2022.

Today, twenty countries have replaced their national currencies with the euro, including:

The U.S. dollar and euro are the world’s reserve currencies because they offer political stability and exchangeability. The U.S. dollar index that measures the U.S. currency against the other world reserve foreign exchange instruments has a 57% exposure to the euro.

The euro versus the U.S. dollar currency relationship reached a high of over 1.60 dollars per euro in 2008. Since then, the euro has made lower highs and lower lows against the U.S. dollar. The Invesco CurrencyShares® Euro Currency Trust ETF (NYSEARCA:FXE) measures the euro versus the U.S. dollar relationship. The euro recovered after trading below parity in 2022, but the long-term bearish trend remains intact in June 2023.

A probe below parity

The first major war in Europe, on Western Europe’s doorstep, sent the euro versus the dollar foreign exchange relationship to a two-decade low in 2022.

As the twenty-year chart highlights, the euro fell below parity against the U.S. dollar for the first time since 2002 in July 2022, reaching $0.95364 in September 2022.

Rising U.S. interest rates and the war in Ukraine were a potent bearish force for the euro’s relationship with the U.S. currency. Sanctions on Russia and Russian retaliation only exacerbated the impact on Europe’s economy. As energy prices soared, inflation rose to the highest level in decades, and fears of expanding hostilities with NATO’s involvement in the conflict weighed on the euro’s value.

The euro’s long-term trend is bearish

The bearish trend in the euro did not begin with Russia’s invasion of Ukraine.

The long-term chart shows that the euro has been trending higher since the turn of the century and the introduction of the European currency as a worldwide reserve foreign exchange instrument. The euro’s rally peaked in July 2008, but the global financial meltdown and European sovereign debt crisis weighed on the euro. Flight-to-quality buying lifted the U.S. dollar, the leading reserve currency.

Over the past decade and a half, the euro has made lower lows and lower highs against the U.S. dollar. The bearish trend remains intact in June 2023, with critical technical resistance at the January 2021 $1.23490 high. However, even the most aggressive bear markets rarely move in straight lines.

A recovery since the 2022 lows

After reaching the $0.95364 September 2022 low, the euro ran out of downside steam against the U.S. dollar.

The one-year chart highlights the euro’s recovery over the past nine months, lifting the European currency from the September 2022 low to $1.09470 on April 26, 2023. At the $1.0800 level on June 13, the euro versus the dollar foreign currency relationship remains closer to the late April high than the September 2022 low.

The following factors have supported the euro over the past months:

• The trajectory of U.S. interest rate hikes has slowed after the Fed pushed the Fed Funds Rate from 0.125% in March 2022 to 5.125% in May 2023. Even if the Fed increases the short-term rate by 25 basis points on June 14, which is unlikely after the latest CPI data, the trend in U.S. rate increases will dramatically slow in 2023.
• Warm European winter conditions averted an energy crisis. Europe’s dependence on Russian natural gas flows posed a threat as the 2022/2023 winter approached, but Mother Nature’s temperate season caused energy prices to fall, taking pressure off Europe’s economy.
• Ukraine has been holding Russian advances, boosting confidence that the threat against NATO countries has declined.
• The potential for a BRICS currency that moves the world towards de-dollarization has weighed more on the U.S. currency than the euro.
• The U.S. faces domestic issues, including an over $31.7 trillion debt, political division, high inflation, and the threat of a recession. Moreover, the bifurcation of the world’s nuclear powers threatens the U.S. military and financial leadership role on the geopolitical landscape.

Over the past months, the euro’s recovery was partially a bounce in the European economy but more the decline of the U.S.’s leadership position. While the euro recovered against the U.S. dollar, technical resistance has developed at the $1.10 level, far below the level that would challenge the decade-and-one-half bearish trend for the currency relationship.

Europe faces a dilemma

Europe’s political system remains more closely tied with the United States than the Chinese-Russian alliance. The war has strengthened Europe and U.S. ties. However, China’s emergence as a financial and military power could change the geopolitical landscape over the coming years.

China is on a path to challenge the U.S. for the military and economic leadership position. While the U.S. has been the leader of the free world since the end of WW II, a Chinese challenge is on the horizon.

President Xi is seeking to warm his relations with European leaders. During an April 2023 visit to China, French President Macron said Europe should pursue a strategy "independent of both Washington and Beijing” concerning Taiwan. A recent poll showing 74% of Europeans think the continent should cut its military dependence on the U.S. is music to China’s ears, as an independent Europe decreases U.S. global power. Moreover, 43% of Europeans consider China as a “necessary partner.”

Some European leaders, including President Macron, are taking a wait-and-see strategy regarding tensions between Beijing and Washington. Europe does not want to cut off its nose despite its face by supporting the wrong side in a global economic reshuffling that increases China’s power at the expense of the U.S.

Meanwhile, the Chinese-Russian “no-limits” alliance may only strengthen Chinese-European relations if Beijing can world out a deal to end the war over the coming months. If President Xi emerged as the peacemaker, his support in Europe would only increase. Increasing Chinese-European economic ties weaken the U.S. position and could cause the dollar to decline against the euro. Moreover, European trading partners’ acceptance of a BRICS currency may accelerate the dollar’s decline and boost the euro’s value against the U.S. currency.

Some say, “May you live in interesting times,” is a Chinese curse. For the U.S., warming Chinese-European economic ties could cause very interesting times for the U.S.’s global position. The critical level in the euro versus the dollar currency relationship is the January 2021 $1.2349 high. A move above that level would end a fifteen-year bear market for the currency pair.

FXE is the euro versus the U.S. dollar ETF product

The most direct route for a risk position in the euro versus the U.S. dollar is via the over-the-counter foreign exchange market or the Chicago Mercantile Exchange futures and futures options. The Invesco CurrencyShares® Euro Currency Trust ETF provides market participants an alternative to the OTC or futures products.

At $99.72 per share on June 13, FXE had around $278 million in assets under management. FXE trades an average of 70,525 shares daily and charges a 0.40% management fee.

The euro versus the U.S. dollar currency relationship rose 14.8% from $0.95364 in September 2022 to its latest $1.0947 high in late April 2023.

Over the same period, FXE rose 15.9% from $88.37 to $102.44 per share, as the ETF does an excellent job tracking the currency pair.

One of the drawbacks of FXE and other ETFs is they only trade when the U.S. stock market operates. Since the international foreign exchange market trades around the clock, the ETFs can miss highs or lows when the U.S. stock market is not open for business.

In June 2023, the war in Ukraine at Western Europe’s doorstep continues to threaten Europe’s economy and safety. However, the warming relations with China may bolster Europe in the coming years, but it may also come at the expense of relations with the United States, its traditional ally. Since markets impact the economic and geopolitical landscapes, we could see lots of volatility in the euro versus the dollar foreign currency relationship over the coming months and years.

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