Thought Leadership in Action

As the effects of the Russian invasion of Ukraine continue to affect the already distressed euro, the currency has become equal to or slightly below the U.S. dollar for the first time in two decades. While that may sound appealing to Americans planning a vacation in Europe, it also could put stress on exports and U.S. companies abroad, which could affect investment strategies.

What’s Causing the Euro’s Decline?

Many analysts attribute the euro’s recent fall to expectations that the U.S. Federal Reserve’s interest rate increases will combat inflation, according to The Associated Press. As interest rates are raised, the rates on interest-bearing investments typically rise, too. This could attract investment moves from euros to dollar-denominated investments if the Fed raises rates higher than the European Central Bank, driving the euro down and the dollar up.

The ECB has raised rates to prevent inflation from taking hold and avoid a wage-price spiral. That said, a resilient U.S. economy could mean the U.S. Fed raises rates more aggressively than the ECB. The dollar’s strength overall also continues to influence the euro’s comparatively weak performance.

What Are the Economic Effects?

Americans in Europe will find their money going further, with savings on common travel expenses like hotel rooms and restaurants. Imported goods also will have lower prices in the U.S., which could help offset inflation in major categories, such as technology and health care. American businesses with a heavy presence in Europe, however, could be affected because products may become more expensive to sell there. That could widen the trade deficit and reduce the country’s economic output.

“If you’re an importer, the strength of the dollar is a good thing, but it’s a bad thing globally,” says Mark Zandi, chief economist at Moody’s Analytics, adding that he doesn’t expect the dollar to weaken significantly in the near term.

What Should Clients Understand?

Financial advisers should expect clients to ask questions about investing opportunities related to the strong dollar and the relatively weak euro. Advisers should ensure that clients understand the causes of this recent shift and that conditions could change again depending on how Russia’s war in Ukraine progresses and whether inflation tapers off. This is especially important as retail investors flock to foreign-exchange markets, often with little experience.

Now is the time to educate clients and review portfolios. Help them understand that the dollar’s rise against the euro could reverse itself. There also is uncertainty over such factors as interest rates, commodities prices, upcoming U.S. corporate earnings and emerging-market equities.

Clients will seek guidance on these questions when it comes to their personal spending, such as vacations, and their longer-term investments. While financial advisers can’t predict the future, they can ensure clients are well-informed about the meaning of the euro’s parity against the dollars and the possible investment scenarios.