Euro approaches dollar parity as traders brace for recession

Government bond markets rallied and oil prices fell on Tuesday, while the euro approached parity with the US dollar, as markets were gripped by fears of a global recession.

The euro teetered on the edge of hitting $1 for the first time since 2002, as the dollar attracted haven buyers as well as support from the gap between interest rate expectations in the US compared with the eurozone.

Investors have been spooked by business and consumer surveys that indicate a looming US slowdown, with the central bank’s ability to support markets stymied by rampant inflation.

But recession fears are even more intense in Europe, where governments are worried about Moscow cutting off gas supplies, exacerbating an energy shock and cost of living crisis.

Futures linked to TTF, the European wholesale gas price, were 2.4 per cent higher at €173.25 per megawatt-hour, more than double their level of early June.

Foreign exchange markets are “discounting a severe European recession”, into the euro-dollar trade, Greg Anderson and Stephen Gallo of BMO Capital Markets wrote in a note to clients.

“This scenario has close links with energy supply constraints,” they said, as well as “winter (or even summer) fuel rationing”.

The yield on Germany’s 10-year Bund, a barometer for debt costs in the eurozone, fell 0.13 percentage points to 1.12 per cent as economic uncertainty drove demand for the low-risk asset. Bond yields fall as prices rise.

US government debt yields also fell, while continuing to trade in a so-called inverted yield curve pattern that has historically predicted recessions.

The 10-year Treasury yield, which underpins debt costs worldwide, fell 0.08 percentage points to 2.92 per cent. The two-year yield fell 0.07 percentage points to 3 per cent.

Brent crude, the oil benchmark, dropped 4.5 per cent to just over $102 a barrel.

Analysts expect the US Federal Reserve to raise interest rates by as much as 0.75 percentage points at its July meeting, from a current range of 1.5 per cent to 1.75 per cent. Futures markets point to a benchmark US interest rate of just under 3.5 per cent for early 2023.

By comparison, futures tip the European Central Bank to tighten monetary policy more slowly, nudging its deposit rate from minus 0.5 per cent currently to just over 1 per cent by next March.

The dollar index, which measures the greenback against six currencies and has a heavy euro weighting, added 0.1 per cent to trade at around its strongest level in two decades.

In stock markets, Wall Street’s S&P 500 share index added 0.4 per cent in early New York dealings, while the technology-focused Nasdaq Composite rose 0.9 per cent. Europe’s Stoxx 600 rose 0.1 per cent.

The FTSE All-World index of developed and emerging market shares has fallen more than 20 per cent this year as higher interest rates raise borrowing costs and drag down stock market valuations. Investors are now poised for the second-quarter corporate earnings season for news of how companies are being affected by inflation and weak consumer sentiment.

“We see the bear market in two phases. The first part is interest rate driven and the second part is earnings driven,” said Trevor Greetham, head of multi-asset at Royal London Asset Management. “There will be a recession and that will cause a lot of weakness in earnings that’s yet to start.”