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There has been a lot of chatter in recent weeks about whether or not EUR/USD will reach parity. It’s one of those things that as it builds up more and more, momentum trading tends to take over, with fundamentals pushed to one side in the short-term. With the pair marking a low of 1.001 earlier today, parity has been all but hit. So the question becomes, where from here?

How we got here

EUR/USD is down 12% year to date, with 4.5% of that move coming in July so far. The move has accelerated to the downside in recent weeks.

Apart from the momentum trading, there are some valid reasons for the dip. One of them is the continued rise of natural gas prices. This hurts the Eurozone in particular, with the damage perhaps not even over yet. If Russia become more aggressive and turn off the taps as it were on Nordstream 1, the bloc could struggle even further with energy needs.

The interest rate differential is another driver here. The US Fed raised rates by 0.75% in June, with another 0.75% hike due at the next meeting. The ECB haven’t made a move yet, but have signaled a 0.25% hike later in July. It’s clear to see two different stances here on monetary policy. For investors wanting yield, it makes sense to sell EUR, buy USD.

Why parity doesn’t really matter

Parity is a psychological barrier for the pair. Yet history shows us that back in the early 2000’s, the pair easily traded below this level.

EUR/CHF broke below parity earlier in the month and has been able to move even lower in the immediate aftermath, highlighting again how parity isn’t that much of a dealmaker/breaker as some technical traders might state.

Indeed, when we look at the core drivers of this move (Nat Gas and Interest Rates), there’s nothing to suggest that a psychological trading level will be able to hold against these much larger drivers. Rather, we think that EUR/USD will finish below parity come the end of the year.

In the next few days, we could see a short squeeze that pushes the pair back to 1.02-1.05. However, we’d use this as an opportunity to short the pair, as we think a lot in the market would also do. From there, we think 0.95-0.97 could be a realistic target range by year end, if the situation doesn’t improve with Russia, and the US keep hiking.

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