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The EUR-USD pair – what does it mean for your portfolio?

Last Thursday (July 14), the EUR/USD currency pair briefly dipped below parity, with the Euro hitting a low of 0.99517 US cents according to regulated CFD broker ActivTrades. To find a similar situation, we have to go back to November 2002, when the single currency was only in its infancy. Over time, the euro strengthened against the dollar and has remained above parity ever since.

EUR/USD daily chart – Source: ActivTrader online trading platform

Although it has bounced above parity since then, at around $1.00976 at the time of writing, many analysts believe that the EUR/USD pair is poised to continue lower, mainly due to the difference in monetary policies between the United States and Europe, as well as the deterioration of the trade and current balance of Europe. Let’s take a closer look at what the EUR-USD pair means for your portfolio.

Understand why the euro is close to parity with the dollar

The first thing to note about how the EUR/USD pair moves is that it is not the Euro that is weakening, but rather the US Dollar that is strengthening.

The main reason for this performance lies in the rate differentials between the United States and the euro zone, with the Federal Reserve (Fed) having already started to raise its main interest rates, while the European Central Bank (ECB) is expected to begin his hiking pace rate this Thursday. The Fed is therefore overall much more aggressive than the ECB in its fight against inflation and is raising interest rates very quickly, while the ECB is more cautious.

For example, markets expect the Fed to raise interest rates 9 to 10 times by the start of 2023. In July, the Fed is expected to do something that has never been done before by increasing rates by 1 percentage point, or 100 basis points. . Investors will be watching the ECB’s meeting and press conference closely for clues as to what the central bank has decided to do to combat record inflation.

This situation pushes traders and investors towards the dollar and away from the euro. But another reason for the fall of the EUR/USD is the conflict in Ukraine, which has fueled fears of an energy crisis due to the heavy dependence of European countries on Russian oil and gas.

Amid growing danger to Europe’s energy supply, the armed conflict has sparked widespread concern about the region’s macroeconomic outlook due to increasingly difficult economic conditions for the Eurozone, which is having a significant impact on the level of trade between Europe and the rest of the world.

While the United States and Europe have seen their trade balances deteriorate, the euro zone’s trade surplus has shrunk much faster due to higher European natural gas and oil prices, which have deteriorated the euro area terms of trade and have also had an impact on the single currency. request.

Germany, Europe’s largest economy, recently recorded its first monthly trade deficit in more than 30 years (a shortfall of 1 billion euros) as companies grappled with rising costs imports and declining demand for their goods.

EUR-USD winners and losers

Changes in the value of the two most traded currencies in the world have a significant effect on companies that sell their goods abroad or use raw materials from other countries, as well as on local and international consumers.

Winners and losers of a weak euro

● European exporters, whose products are sold in euros, are now selling cheaper products internationally, which allows them to attract more customers and gain market share.

● US travelers to Europe can get more for their dollar.

● European imports are more expensive.

● Due to a weak euro, the conversion by American multinationals of their profits repatriated from Europe will be weaker.

Strong dollar winners and losers

● European exporters, whose products are sold in USD, can obtain a higher margin.

● US exporters, whose products are sold in USD, now have products that are more expensive and less competitive on world markets.

● US imports are cheaper.

● European importers are now faced with higher production costs, especially since most raw materials are denominated in USD.

● US tourism could slow.

● US investors have more reason to save and invest their cash locally.

What does the EUR-USD parity mean for your portfolio?

Depending on whether you invest mainly (or exclusively) in USD or EUR, your portfolio is confronted with an exchange rate which can be positive or negative.

The first risk of the EUR-USD parity on your portfolio comes from the impact of the fluctuation of the exchange rate on the sales, profits and growth prospects of companies, which will certainly impact their share price and the performance of your wallet.

Another risk comes from how the companies in your portfolio hedge against the impact of changes in exchange rates with derivatives such as forwards and futures. With such financial products, companies can freeze the exchange rate for a specific agreed period of time to avoid being negatively impacted. However, the results are not always positive for businesses.

If you are investing for the long term, it is therefore important to know how the companies in which you have invested cover their international exposure to exchange rate risks. This is especially true for companies that rely heavily on exports, as their hedging strategy can have a big effect on their performance.

Now let’s talk about the composition of your portfolio itself.

If you live in a euro zone country and you invest in EUR, you will have no exchange rate risk in your portfolio other than the results of the companies you own, which could be negatively impacted.

If you reside in a euro zone country and you invest in companies or financial products outside the euro zone (i.e. not in EUR), then you will have to bear a currency risk when you convert your profits into EUR (in EUR). plus the impact of the exchange rate on the prices of the companies you own).

Looking for ways to limit the impact of the exchange rate on your portfolio?

Well, you can invest exclusively in one currency, but that’s not the best option because it means you won’t really have a diversified portfolio.

You can also use a Currency Hedged ETF to manage the currency risk of your investments, as these types of ETFs protect their holders against the impact of exchange rate fluctuations (whether the impact is positive or negative). for the investor).

Finally, it is also possible to hedge your portfolio with financial products such as CFDs or Contracts for Difference. The best method may not be to hedge each of your positions but to protect your portfolio globally, depending on your currency exposure.

This article was written by Carolane de Palmas.


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