Last Thursday (July 14th), the EUR/USD currency pair briefly dropped below parity, with the Euro reaching a low of $0.99517 US cents according to the regulated CFD broker ActivTrades. To find a similar situation, you need to get back to November 2002, when the single currency was only getting started. Over time, the Euro got stronger against the Dollar, and it has stayed above parity ever since.

EUR/USD Daily Chart - Source: Online ActivTrader Trading Platform

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

Understanding why the euro is close to parity with the dollar

The first thing to highlight regarding the way the EUR/USD pair moves is that it isn’t the Euro that is weakening, but rather mostly the American Dollar that is strengthening.

The main reason behind this performance is the rate differentials between the United States and the Euro Zone, as the Federal Reserve (Fed) has already started to increase its main interest rates, while the European Central Bank (ECB) is expected to start its rate hike pace this Thursday. The Fed is, therefore, globally much more aggressive than the ECB in its battle against inflation and is increasing interest rates very rapidly, while the ECB is more cautious.

For example, the markets expect the Fed to raise interest rates 9 to 10 times between now and early 2023. In July, the Fed is likely to do something that has never been done before by raising rates by 1 percentage point, or 100 basis points. Investors will be closely watching the ECB meeting and press conference for clues about what the central bank has decided to do to fight record-high inflation.

This situation is pushing traders and investors toward the dollar and away from the euro. But another reason behind the EUR/USD fall is the conflict in Ukraine, which has fueled fear of an energy crunch due to the strong dependence of European countries on Russian oil and gas.

Amid the growing danger to the European energy supply, the armed conflict has cast widespread worry over the region's macroeconomic prospects because of the increasingly difficult economic conditions for the Euro Zone, which greatly impacts the level of trade between Europe and the rest of the world.

While both the U.S. and Europe have seen their trade balances get worse, the eurozone's trade surplus has gone down much more quickly due to rising prices of European natural gas and oil, which have deteriorated the Euro Zone's terms of trade and also impacted the single currency demand.

Germany, the biggest economy in Europe, recently recorded its first monthly trade deficit in more than 30 years (a shortfall of 1 billion euros), because companies had to deal with rising costs for imports and less demand for their goods.

The EUR-USD winners and losers

Changes in the value of the two most traded currencies in the world have a big 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 EUR, are now selling cheaper products internationally, which means that they can attract more clients and win market share.

● American travelers to Europe can get more for their USD.

● European imports are more expensive.

● Because of a weak euro, U.S. multinationals' conversion of their repatriated profits from Europe will be lower.

Winners and losers of a strong dollar

● European exporters, whose products are sold in USD, can get a greater margin.

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

● American imports are cheaper.

● European importers now have to face greater production costs, especially as most commodities are priced in USD.

● Tourism in the United States might slow down.

● American investors have more reasons to save and invest their cash locally.

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

Depending on whether you’re mostly (or exclusively) invested in USD or in EUR, your portfolio faces an exchange rate that could either be positive or negative.

The first risk of the EUR-USD parity on your portfolio comes from the impact of the exchange rate fluctuation on companies’ sales, earnings, and growth prospects, which will definitely impact their stock price and the performance of your portfolio.

Another risk comes from the way companies in your portfolio protect themselves against the impact of exchange rate changes with derivatives such as futures and forwards. With such financial products, companies can freeze the exchange rate over an agreed-upon specific period of time to avoid being negatively impacted. However, the results aren't always positive for companies.

If you’re invested for the long run, it’s therefore important to know how the companies you’ve invested in are hedging their international exposure when it comes to currency risks. This is especially true for companies that depend heavily on exports since their hedging strategy can have a big effect on how well they do.

Let’s talk now about the composition of your portfolio itself.

If you live in a EuroZone country and you’re invested in EUR, then you won’t have any currency risk in your portfolio other than the results of the companies you hold that might be negatively impacted.

If you live in a EuroZone country and you’re invested in companies or financial products outside the euro area (so not in EUR), then you will have to bear a currency risk when you convert your profits into EUR (in addition to the impact of the exchange rate on the prices of companies you hold).

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

Well, you can invest exclusively in one currency, but this isn’t the best option, as this means that you won’t really have a diversified portfolio.

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

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

This article was written by Carolane de Palmas.

Last Thursday (July 14th), the EUR/USD currency pair briefly dropped below parity, with the Euro reaching a low of $0.99517 US cents according to the regulated CFD broker ActivTrades. To find a similar situation, you need to get back to November 2002, when the single currency was only getting started. Over time, the Euro got stronger against the Dollar, and it has stayed above parity ever since.

EUR/USD Daily Chart - Source: Online ActivTrader Trading Platform

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

Understanding why the euro is close to parity with the dollar

The first thing to highlight regarding the way the EUR/USD pair moves is that it isn’t the Euro that is weakening, but rather mostly the American Dollar that is strengthening.

The main reason behind this performance is the rate differentials between the United States and the Euro Zone, as the Federal Reserve (Fed) has already started to increase its main interest rates, while the European Central Bank (ECB) is expected to start its rate hike pace this Thursday. The Fed is, therefore, globally much more aggressive than the ECB in its battle against inflation and is increasing interest rates very rapidly, while the ECB is more cautious.

For example, the markets expect the Fed to raise interest rates 9 to 10 times between now and early 2023. In July, the Fed is likely to do something that has never been done before by raising rates by 1 percentage point, or 100 basis points. Investors will be closely watching the ECB meeting and press conference for clues about what the central bank has decided to do to fight record-high inflation.

This situation is pushing traders and investors toward the dollar and away from the euro. But another reason behind the EUR/USD fall is the conflict in Ukraine, which has fueled fear of an energy crunch due to the strong dependence of European countries on Russian oil and gas.

Amid the growing danger to the European energy supply, the armed conflict has cast widespread worry over the region's macroeconomic prospects because of the increasingly difficult economic conditions for the Euro Zone, which greatly impacts the level of trade between Europe and the rest of the world.

While both the U.S. and Europe have seen their trade balances get worse, the eurozone's trade surplus has gone down much more quickly due to rising prices of European natural gas and oil, which have deteriorated the Euro Zone's terms of trade and also impacted the single currency demand.

Germany, the biggest economy in Europe, recently recorded its first monthly trade deficit in more than 30 years (a shortfall of 1 billion euros), because companies had to deal with rising costs for imports and less demand for their goods.

The EUR-USD winners and losers

Changes in the value of the two most traded currencies in the world have a big 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 EUR, are now selling cheaper products internationally, which means that they can attract more clients and win market share.

● American travelers to Europe can get more for their USD.

● European imports are more expensive.

● Because of a weak euro, U.S. multinationals' conversion of their repatriated profits from Europe will be lower.

Winners and losers of a strong dollar

● European exporters, whose products are sold in USD, can get a greater margin.

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

● American imports are cheaper.

● European importers now have to face greater production costs, especially as most commodities are priced in USD.

● Tourism in the United States might slow down.

● American investors have more reasons to save and invest their cash locally.

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

Depending on whether you’re mostly (or exclusively) invested in USD or in EUR, your portfolio faces an exchange rate that could either be positive or negative.

The first risk of the EUR-USD parity on your portfolio comes from the impact of the exchange rate fluctuation on companies’ sales, earnings, and growth prospects, which will definitely impact their stock price and the performance of your portfolio.

Another risk comes from the way companies in your portfolio protect themselves against the impact of exchange rate changes with derivatives such as futures and forwards. With such financial products, companies can freeze the exchange rate over an agreed-upon specific period of time to avoid being negatively impacted. However, the results aren't always positive for companies.

If you’re invested for the long run, it’s therefore important to know how the companies you’ve invested in are hedging their international exposure when it comes to currency risks. This is especially true for companies that depend heavily on exports since their hedging strategy can have a big effect on how well they do.

Let’s talk now about the composition of your portfolio itself.

If you live in a EuroZone country and you’re invested in EUR, then you won’t have any currency risk in your portfolio other than the results of the companies you hold that might be negatively impacted.

If you live in a EuroZone country and you’re invested in companies or financial products outside the euro area (so not in EUR), then you will have to bear a currency risk when you convert your profits into EUR (in addition to the impact of the exchange rate on the prices of companies you hold).

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

Well, you can invest exclusively in one currency, but this isn’t the best option, as this means that you won’t really have a diversified portfolio.

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

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

This article was written by Carolane de Palmas.