EUR/CHF Parity Could Signal Further Euro Declines

The steep drop in the euro has come back into focus this week with EURUSD plunging to fresh 2022 lows, now down close to 10% on the year. However, perhaps the most notable development is EURCHF holding below parity for the first time since the currency peg was removed in 2015.

While the pair tested below parity earlier in the year, the move was quickly rebuffed. However, with EUR sinking across the board, the move looks likely to hold this time and given the general backdrop traders are now asking whether EURUSD will be the next pair to sink below parity or whether EUR is likely to reverse in the near-term.

In order to assess this, let’s take a look at what has been driving price action this year and how these factors are likely to develop going forward.

What has been driving EURUSD and EURCHF this year?

• Dovish ECB Vs G10 Central Banks
• Policy shift at the ECB / EZ recession risk
• Unexpected SNB Rate hike

Dovish ECB Vs G10 central banks

Over much of the first half of the year, EUR was driven lower as a result of the monetary policy divergence between the ECB and Fed, as well as other hawkish central banks within the G10. With the ECB battling the fallout from the Ukraine war, the eurozone economy was thought to be too fragile to withstand any tightening and the ECB reaffirmed its commitment to maintaining an easing presence in the market.

Shift in ECB sentiment

Since Q2, however, there is an important shift. The ECB is no longer able to ignore spiralling inflation nor could they any longer categorise the rise as transitory. With price soaring across the eurozone, the ECB began to lay the groundwork for the first rate-hike in over a decade.

The sudden shift in outlook from the ECB affected a pause in the EURUSD decline as traders digested the shifting landscape. The central bank has since turned more hawkish and announced 50 basis points in July and signalled further rate hikes in the coming months, committing itself to bringing inflation back to 2%.

Unexpected SNB rate hike

However, the sudden shift at the ECB was not the only major surprise on the central bank front this month. The SNB front-ran the ECB’s July hike with an unexpected 50bps hike in June.

In the face of slower than elsewhere but quickly-expanding Swiss inflation, the SNB announced the move and signalled the likelihood of further hikes to come this year as it too battles inflation. Notably, the SNB was even seen refraining from its usual comments around the strength of the Franc. With Switzerland losing its status as having the lowest interest rates globally, CHF saw a seismic shift in price action, reflected in the swift drop below parity in EURCHF.

Bearish outlook for EUR

Given the more vulnerable nature of the eurozone economy with regard to the ongoing conflict in Ukraine, the risks look skewed towards further downside.

The ECB’s shift in tone was largely upstaged by more aggressive action from the Fed in June and with further such action expected this month and across the remainder of the year, it seems hard to think the ECB will be able to play catch-up, especially given the more idiosyncratic risks the eurozone faces.

Indeed, the ECB’s planned monetary policy normalisation is adding to growth fears in the eurozone, heightening the risk of recession there, which will no doubt create a further drag on EUR. Both USD and CHF stand to benefit, not just from central bank hawkishness, but also from increases safe-haven demand amidst any further market volatility this year.

EUR bullish risks

It’s important to highlight the risks to this outlook. Given the level of built-up hawkish Fed expectations. If the Fed is seen pausing rate hikes or greatly reducing the pace of hikes over the remainder of the year, this might allow EURUSD to recover. Similarly, if recessionary risks die down and safe-haven demand fades, EURCHF might find similar room to recover.

EURUSD – Monthly chart

The breakdown below parity, a long-term support level, is a major bearish development. While the price has recovered somewhat since the sentiment and momentum remain weak. The bulls need to see a break back above 1.0800 to negate this view.

EURCHF – Weekly Chart

EURCHF has been grinding lower within a well-defined bear channel over the last few years. Recently, we’ve seen prices blowing through parity and falling as low as 0.9700. Down here, the outlook is not very cheerful and the pair could see a leg lower unless the SNB surprises markets with a less hawkish tone.