The euro burst on the scene on January 1, 1999. It was an invisible currency for the first years, with only accounting and electronic payments. In 2002, euro notes and coins replaced many of Europe’s money as the German mark, French franc, Dutch guilder, Spanish peseta, Italian lira, Greek drachma, and other foreign exchange legal tender faded into history. The euro quickly became a reserve currency. In 2020, while the U.S. dollar accounted for around 38.7% of total global payments, the euro had a 36.7% market share.
Since its inception, the euro experienced a 2008 sovereign debt crisis, as the northern countries had to bail out the southern European countries that faced debt defaults. However, the war that started in 2022 in Ukraine on Europe’s border has posed a significant challenge that pushed the euro to a two-decade low in 2023.
The Currency Shares Euro Trust (FXE) is an ETF that moves higher and lower with the euro’s value against the U.S. dollar.
The euro is the dominant currency in the U.S. dollar index
As the reserve currency second only to the U.S. dollar, the dollar index has the most significant exposure to the euro.
Source: ICE
As the chart shows, the dollar index has a 57.6% weighting to the European currency.
The euro has recovered against the dollar since the 2022 low
In September 2022, the euro fell to its lowest level against the U.S. currency since 2002.
The long-term chart highlights the euro’s decline below parity in July through November 2022. Last September, it reached a bottom at a $0.95364 exchange rate for the currency pair, pushing the dollar index to a twenty-year high.
The dollar index chart illustrates the rise to 114.780, the highest level since 2002.
Meanwhile, the euro has recovered since last September, pushing the dollar index lower.
In 2023, the euro versus the U.S. dollar currency relationship has made higher lows and higher highs, peaking at $1.12754 in mid-July, where it ran out of upside steam. Over the past weeks, the euro has declined against the U.S. foreign exchange instrument.
War in Europe is not bullish for the euro
In late February 2022, Russia invaded Ukraine, igniting the first major war on Western Europe’s doorstep since WW II. Sanctions on Russia and Russian retaliation have weighed on the euro’s value. The economic, political, and social consequences of war and Europe’s support for Ukraine have been bearish for the euro, sending the European currency to the two-decade low against the dollar. Moreover, flight-to-quality buying in the dollar during the upheaval and uncertain geopolitical landscape only exacerbated the euro’s decline.
In September 2023, the war continues to rage, with no end in sight. The battle for Ukraine and Western Europe’s proximity is bearish for the euro’s value against other world currencies, including the U.S. dollar.
U.S. foreign policy is critical for the euro’s value
Western Europe and the U.S. are allies in NATO, the North Atlantic Treaty Organization, created in 1949 to provide collective security against the former Soviet Union. While the Soviet Union collapsed, the Russian Federation’s attack on Ukraine gave NATO a new purpose. Moreover, military support for Ukraine has increased the potential for war with the NATO allies as the organization’s charter states an attack on one member is an attack on all. The war in Ukraine borders on NATO countries, and voices in Russia have called the increasing support for Ukraine a war declaration.
U.S. foreign policy towards NATO and Russia is critical, but Washington’s relations with Beijing also are crucial.
Russia and China formed a “no-limits” alliance in February 2022, and while Russia invaded Ukraine, Chinese plans for reunification with Taiwan remain a clear and present danger to world peace. Meanwhile, China is the world’s second-leading economy and a significant European trading partner. Therefore, U.S. foreign policy will determine Europe’s future relations with the Chinese government. Since currency markets reflect the economic and geopolitical landscape, the bifurcation of the world’s nuclear powers could cause volatility in the euro versus the U.S. dollar currency pair over the coming months and years.
A BRICS currency could damage the U.S. and European currencies’ global roles
The economic fallout from the war in Ukraine and sanctions on Russia has caused BRICS countries, including Brazil, Russia, India, China, South Africa, and their allies, to move towards a BRICS currency to challenge the dollar’s dominant role in global trade. Over the past months, China has purchased Saudi crude oil in yuan, and India has paid OPEC members for the energy commodity in rupees. A BRICS currency that could have gold backing would alter the worldwide economic landscape, diminishing the dollar’s role. Europe could become a lynchpin for determining the success of a BRICS foreign exchange instrument. If economic issues cause Europe to accept and transact with another currency, it may cause increased volatility in the foreign exchange arena.
Meanwhile, if Europe sticks with the U.S., the use of BRICS currency for cross-border transactions may only cause the role of the dollar and the euro to decline.
The foreign exchange market underwent a significant change when the euro burst on the scene around the turn of this century. A BRICS currency could alter the landscape in the coming years. When it comes to the euro, Europe has some critical decisions ahead. While the war in Ukraine is on Europe’s doorstep, which is bearish for the euro, the potential for a new currency puts the euro in a position where it has some decisions that will impact its economic future as the geopolitical landscape undergoes significant changes.
Expect volatility in the euro versus the U.S. dollar currency relationship. The most direct route for a risk position in the currency pair is via the over-the-counter foreign exchange market or the futures arena. The Currency Shares Euro Trust (FXE) is an alternative as it moves higher and lower with the euro versus the dollar currency pair. At $98.78 per share on September 8, FXE had around $232.2 million in assets under management. FXE trades an average of nearly 85,000 shares daily and charges a 0.40% management fee.
As of September 8, the short-term trend in the euro versus the dollar is lower. Economic and geopolitical events over the coming months will likely have the most significant impact on the path of least resistance of the value relationship between the world’s leading reserve currencies.
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
