Can the Euro Defy Parity against U.S. Dollar in Event of 75bp Fed Rate Hike

The Euro to Dollar exchange rate will unlikely to make another test of July lows below parity this week says UniCredit.

The call comes ahead of another expect interest rate rise at the U.S. Federal Reserve, where markets are fully priced for a further 75 basis point increase.

"The ability of EUR-USD to hold the line above 1.01 will probably help the pair to weather the 75bp rate hike we expect the Fed to deliver on Wednesday," says Roberto Mialich, FX Strategist, at UniCredit Bank in Milan.

The Euro-Dollar exchange rate fell to a 20-year low at 0.9952 on July 14, but it has since recovered back to 1.0148 at the time of writing. (Set your FX rate alert here).

The Dollar's advance into mid-July was driven by an expectation for further interest rate increases at the Federal Reserve, with investors at one point pricing in a sizeable 100 basis point hike following the release of stronger than expected inflation data.

But Federal Reserve board governors were reticent to confirm the market's move to price in a 100 basis point hike, instead signalling 75bp was preferred.

Accordingly the market rolled back its expectations and the Dollar eased back, allowing a Euro-Dollar rate recovery.

"Remarks by some Fed members partially softened this stance, but the debate remains open. We also see a 75bp move as more likely than a 100bp hike. If this is the case, the move is unlikely to boost the USD as it is already widely anticipated," says Mialich.

"EUR-USD would keep a re-test of parity far away in this case," he adds.

UniCredit tells clients markets will probably be even more sensitive to the press conference by Fed Chair Jerome Powell in terms of the peak in the current tightening cycle that the Fed will indicate.

Money market pricing shows investors expect the Fed Funds rate to peak at close to 3.75% by the first quarter of 2023, while the European Central Bank is expected to end its hiking cycle close to 1.50% by the end of 2023.

This maintains a sizeable yield advantage for the Dollar over the Euro, underscoring why UniCredit maintain the Euro has limited potential for a near-term recovery.

"Buying interest in the aftermath of the ECB decisions halted around 1.0275, thus without EUR-USD returning towards the 1.03-1.0340 area, a definitive break with which is still required to close the gap with respect to the previous drop and run a more-sustained recovery," says Mialich.

UniCredit forecasts the Euro-Dollar exchange rate to be at 1.03 by the end of September, ahead of a further gradual recovery to 1.06 by year-end.

This theme of gradual recovery extends into 2023 where the exchange rate is seen finding the year towards 1.12.