Following on from my “parity party” post, I have done a bit more thinking on euro. And maybe I am getting caught up in the hype. Here are a few charts maybe make the case for parity (or worse) a little tougher.
Much of the focus is on relative monetary stance of the US and euro area. And they are undoubtedly moving in opposite directions, which is relatively unusual. However, the magnitude of the difference is actually not that large by standards of the past. Here is a long-run chart of the euro against the spread between 2yr German and US govt bonds (best I could do to take it back a decent period):
Deviations around the zero line have been much greater in the 1990s and again in the mid-2000s. The magnitude of the move we have seen in the euro in the past six months looks outsized relative to the long-run rates differential.
That said, over a shorter look-back to the post-crisis period, the relationship looks a bit stronger and the levels more aligned:
The other thing often cited is central bank balance sheets, as they might contain additional information over and above the (short) rate differential. But the chart below is not particularly compelling either. The expected increase in the ECB balance sheet relative to the Fed’s is large, but no more so than the moves seen in 2011-13. Again the euro move looks to be out-sized already.One might argue that asset purchases are different to liquidity operations when it comes to exchange rate effects, and so the move down in 2011/12 should be discounted (that is the first ECB LTRO op):
Of course, as we all know, exchange rates tend to overshoot, so these arguments don’t preclude the current momentum taking the euro to parity, they just suggest that maybe it is harder to justify.