(Bloomberg) -- The risk of the euro sliding to parity with the dollar is mounting in financial markets after this week’s interest-rate cut and a stark reminder that a Donald Trump presidency could spark a global trade war.
Just days after Trump suggested US tariffs could be aimed at Europe as well as China and other countries, European Central Bank President Christine Lagarde warned that any barriers would pose a “downside risk” for the bloc’s struggling economy. On Thursday, she delivered a second interest-rate cut in a row and sparked bets on even more aggressive reductions to come.
The combination sent the euro tumbling, putting it on track for its third-straight week of losses against the greenback.
“Euro-dollar parity is definitely a possibility if Trump wins and goes full monty on tariffs,” said Michael Hart, senior currency strategist at Pictet Wealth Management.
Pictet and Deutsche Bank AG no longer consider a scenario where one euro buys a single dollar to be far-fetched, while J.P. Morgan Private Bank and ING Groep NV see the risk that the common currency could fall toward that level before the year is out.
The curdling sentiment was on display as hedge funds increased their bets against the euro as of Oct. 15, becoming most negative on the currency in two months, according to Commodity Futures Trading Commission data released on Friday.
In the options market, traders are also ramping up bearish bets against the common currency.
A gauge of risk reversals over the next month — or how expensive it is to buy options that benefit from a currency’s gains relative to those that target weakness — is near the most negative on the euro-dollar pair in three months, showing an appetite to bet on euro pain.
Options to protect against a weaker euro in the short term are concentrated on a fall to the $1.08-$1.07 area, according to data from the Depository Trust & Clearing Corporation. Interest in protecting against a slide to $1.05 is on the rise, while parity trades comprise a small fraction of total volumes, for now.
“We like long dollar against the euro, given the sensitivity of Europe to shifts in foreign policy and the prospect of broad tariffs under Trump,” said Aroop Chatterjee, a strategist at Wells Fargo.
The Chinese yuan, Mexican peso and Japanese yen are typically seen as the main lightning rods for fresh US trade restrictions, but Europe’s lackluster economy makes the euro vulnerable. US tariffs could crimp global trade just as growth is slowing and central banks are cutting rates.
What Bloomberg strategists say...
“Expectations of an aggressive ECB monetary-policy easing, coupled with other headwinds, risks boosting talk of the euro finding its way back to parity in 2025 — a scenario markets look to be currently largely discounting.”
Nour Al Ali, Macro Markets & Squawk, London. Read more on MLIV.
Money markets imply a 30% chance the ECB will deliver a half-point cut at the final meeting of the year and are fully priced for quarter-point reductions at every meeting through April. The euro rose 0.3% against the dollar to $1.0864 on Friday, set for its third week of losses, the longest streak since June.
“A Trump election and a tariff war is looming which could force the ECB into further action to keep the currency weak and remain competitive,” said Kaspar Hense, senior portfolio manager at RBC BlueBay Asset Management.
In an interview with Bloomberg earlier this week, Trump described tariffs as “the most beautiful word in the dictionary.” Singling out Europe, he added: “You know what’s tough? the European Union. They treat us so badly we have a deficit.”
Though the outcome of the election remains too close to call, George Saravelos, global head of FX research at Deutsche Bank, says a global trade war involving China would drive the ECB to cut rates more aggressively than markets are currently pricing.
“This would take rate spreads to all-time historical extremes and the euro-dollar pair down to around 1.00,” he wrote earlier this month.
--With assistance from Carter Johnson and Vassilis Karamanis.
(Updates euro pricing and adds CFTC positioning data.)
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