Euro Risks Slide to Parity as Ukraine War’s ‘Most Liquid Short’

(Bloomberg) -- What seemed almost impossible a few months ago is now growing into an appreciable risk: the euro may sink to parity with the dollar this year.

That's what strategists are warning as the Russian invasion of Ukraine threatens to derail the European economic recovery from the pandemic and delay even further the European Central Bank's glacial progress toward policy normalization.

The euro has been one of the worst performers among global currencies during the early stages of the Ukraine war, sliding 4.7% against the dollar over the past month to as low as $1.0886 on Friday, its lowest level since May 2020. Traders have sold the shared currency as the welter of sanctions placed on Russia look to hurt the economies of the European nations most interlinked with Moscow.

The pair found additional momentum lower following U.S. job-growth data that came in well-above economists expectations.

“Right now the euro is the most liquid short available for investors,” said Stephen Miller, an investment consultant at GSFM, a unit of Canada's CI Financial Corp. in Sydney. “The consequences of this conflict are going to last for a long, long time and it's not unimaginable that we see euro test parity with the dollar over a 12-to-18-month horizon.” 

The probability that the euro will drop below parity with the greenback this year has climbed to 11.9%, according to Bloomberg's FX Rate Forecast Model. That compares with odds of just 2.4% a month ago, when most observers still saw the prospect of a full-blown war in Ukraine as unlikely.

The common currency took another leg lower Friday after Ukrainian officials said Russian troops had shelled Europe's largest nuclear power plant, located in the eastern part of their country. That sent the currency through the $1.10 level that it last touched in May 2020.

Adding to the euro's downdraft is the difference between the dovish ECB and hawkish Federal Reserve, which is set to commence a cycle of raising interest rates at its March meeting.

“The war in Ukraine and the divergent monetary policy path between the EU and the Fed are seriously undermining the euro,” said Qi Gao, a currency strategist at Scotiabank in Singapore. “If this war drags on, there is a serious risk the euro will approach parity against the dollar.”

Traders are paying out more than they did during the height of the pandemic in March 2020 for protection against slides in the euro over the next month, according to risk reversals measured by puts over calls. 

“The longevity in this conflict will be a challenge for broader Europe and the weakness of the euro tends to be a natural play linked to this,” said George Boubouras, head of research at hedge fund K2 Asset Management in Melbourne. “I continue to see more pressure on the euro from here.”

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