EUR: what can be expected in 2024?

Where is the euro headed in 2024? To find out, let’s examine the major risk factors that could impact the currency market in the coming months, our analysts’ forecasts and the key dates to watch.

The main risk factors in 2024

A more dangerous and uncertain world

2024 is the year of localised geopolitical risk. Everything began on 7 October 2023 in the Middle East. Since then, the number of friction points has grown: China/Taiwan, China/Philippines, Iran/Pakistan, Russia/Ukraine, Venezuela/Guyana, and others.

Added to this is an intense electoral cycle. More than 40% of world GDP could change hands at elections:

• The US election on 5 November is a key focus of attention. Its outcome could prove a turning point in the war in Ukraine, for example. But this is not the only important election.

• Municipal elections in Turkey on 31 March will probably be won by the ruling AKP party in Istanbul and Ankara.

• Legislative elections in India in April/May are expected to result in a crushing victory for the party of outgoing Prime Minister Narendra Modi.

• Do not forget European elections and the general election in the UK in the second half of the year, which is likely to see the Labour party return to power.

• Lastly, early legislative elections are probable in Israel, leading to the possible departure of Prime Minister Benyamin Netanyahu – a potential turning point in the conflict.

The world at the end of 2024 will be nothing like the world we know today.

Canals in danger

For decades, it was thought that trading routes were secure, but this no longer holds true. The strait at the entry of the Red Sea, through which 21% of global container trade transits, is not safe to navigate today because of the asymmetric war pitting the Iran-backed Houthi rebels against an international coalition including France. Ships are having to be re-routed through the Cape of Good Hope in South Africa, raising freight costs. But this is not sufficient to rekindle inflation. A report published in January by the Bank of England showed that if the Red Sea route is disrupted throughout 2023, this would only raise annual inflation by a meagre 0.4-0.6 points. That said, it would lead to congestion at ports, as was the case during the Covid crisis, destabilising supply chains, particularly in Europe.

Asia is no longer safe either. Shipping routes in Eastern Asia that cross the Taiwan strait and the South China sea, through which 40% of the EU’s external trade transits, could become more dangerous amid mounting tensions between China and neighbouring countries (Taiwan and the Philippines) over the sovereignty of several islands and atolls. Climate change is another factor to consider.

The Panama Canal is no longer fully operational because of an unprecedented drought.

The safe passage of goods is becoming a structural subject for the markets and the economy. This is new.

A different monetary cycle from others

Policy rates are set to be lowered in 2024. This is the only certainty. But when and by how much? This is where the difficulty lies.

There is big disconnect between market expectations and what central bankers are saying. The money market forecasts around 150-160 basis points of rate cuts on both sides of the Atlantic this year.

Central bankers are more sceptical. Their baseline scenario is 50-75 basis points of rate cuts.

This is a differential of almost 100 basis points. One of the two is wrong. We think it is the money market, which is forecasting an aggressive rate-cutting cycle like those seen in the past. But there is one major difference this time: there is no recession.

Consequently, it does not make sense to slash interest rates. This is the message central banks are conveying. This cycle is different. It will take a little time before the markets revise down their expectations.

At the very least, this implies a revival of volatility in the currency market.

The euro: the eternal loser

At the end of 2023, the consensus was optimistic about the euro. Analysts were expecting the eurozone economy to outperform the US economy and capital inflows to provide a structural support for the currency. This is no longer the case. Everything suggests that a weak euro will remain the norm in 2024.

For four principal reasons:

• The euro is overvalued relative to economic fundamentals. In nominal terms (i.e. excluding inflation), the euro’s trade-weighted exchange rate is at an historical high. In real terms (i.e. including inflation), the euro is close to its level in 2014 when the then president of the European Central Bank (ECB), Italy’s Mario Draghi, announced the asset purchase programme (QE, for Quantitative Easing) to lift the eurozone out of the sovereign debt crisis turmoil.

• Weak growth is set to contribute to diverting capital flows from the eurozone to economic areas with higher expected returns (guess which: the United States!). This sluggish economic growth results from the energy shock triggered by the war in Ukraine and continues to be a drag on several big eurozone economies, including Germany, which is likely to be in recession throughout 2024. The steep drop in inflation in EU is obviously good news. But it is also a symptom of a slowdown in internal demand.

• The ECB is hesitating to cut policy rates (also called short rates) when it is urgent to do so to stimulate the economy. The longer it waits, the more it will then have to make sharp and rapid cuts. This is never positive as it results in poor capital allocation (by keeping alive businesses that should have disappeared, for example) and would drive down the euro.

• Fiscal policy is neutral in the eurozone. This means it is not a support for economic growth. In an ideal world, fiscal policy would be more expansionary to boost demand and counter the erosion of real wages. But fiscal space is limited because of high sovereign debt levels.

Every year, analysts repeat that this will finally be the euro’s year. And yet this is rarely the case. Proof of disaffection for the single currency is the euro’s declining share in international trade over recent years. We have been hearing for more than ten years that part of the world is in a dedollarisation process, but the reality is quite different. We are actually seeing more of a de-euroisation process (withdrawal from the euro). According to the latest SWIFT data, the single currency’s share in international payments fell to 23% at the end of 2023 from 38% in January 2023, whereas the US dollar’s share has been stable over the long term. It is difficult to see what could reverse this trend at present.

Key dates to watch

08/02: The US Supreme Court will examine if US states can disqualify Donald Trump from the presidential election because of his attempts to reverse the result of the 2020 elections and his role in the insurrection of 6 January. This is only the start of the former US president’s legal proceedings.

16-18/02: Munich Security Conference. This is normally a non-event. But against the backdrop of the war in Ukraine, this conference is of particular importance this year.

24/02: Second anniversary of Russia’s invasion of Ukraine. This is an endless conflict. This year alone, Ukraine has to send 500,000 more men to the war front. This is unsustainable.

Late-February/March: NATO is due to hold its biggest military exercise since the cold war. The Steadfast Defender – Europe 24 operation will bring together 30 countries and 40,000 soldiers. The exercise will take place in Germany, Poland and Baltic countries and will concentrate on preparations and interoperability in response to a possible Russian invasion.

05/03: Super Tuesday. This term appeared for the first time in 1988. It refers to the first Tuesday in March when a large number of states simultaneously hold their caucus and primary elections for the two dominant American parties. This year, the election will be held in some heavyweight states, such as California and Texas.

06-09/06: European elections. Far-right parties expected to make inroads.

05/11: US presidential election. A victory for Donald Trump could fundamentally change things for Europe. He plans to levy a universal 10% tariff on all goods imported into the US, including from allied countries. Above all, he may end or sharply curtail US financial and military support for Ukraine. Without the US, Ukraine would certainly not be able to hold out for long.