Morgan Stanley analyst Stephen Hull says the euro has much farther to fall, but the dollar should strengthen in 2010 and the euro zone may very well disband.
“Having reached our 1.24 target in EUR/USD, we now expect a decline to 1.16 by year-end and for the euro to trade at a discount to fair value (1.17) in early 2011," reaching a trough around 1.12 before recovering later in the year, Hull writes in a note to investors.
Friday, the euro dropped below $1.20 for the first time in more than four years as a Hungarian official's warning about the state of his country's economy underlined fears about Europe's prospects.
The 16-nation currency traded as low as $1.1973 — its weakest level since it bought $1.1920 in March 2006 and well below the $1.2182 it bought in New York late Thursday.
The euro has weakened on worries about Europe's growth prospects and the effects of government spending cuts being pushed through in the wake of the euro zone debt crisis.
Meanwhile, Hull also thinks that breakup of the euro zone is likely.
"The shift from the initial fiscal problem in the periphery (Greece) has now become a fiscal problem for core Europe," he says. "More importantly for the euro, it has also undermined the credibility of the ECB."
"The ECB’s priority has not been to focus on the euro as a store of value but has shifted to helping stabilize the situation,” Hull says.
Furthermore, the central bank’s role as a lender of last resort has been fully tested and its independence undermined because it is now buying government bonds to help ease Europe’s debt problem.
"There is little doubt in our minds now that through this crisis there is growing evidence that the euro is no longer a hard currency like the Deutsche mark but something softer," Hull says.
If this is the case, he notes, then euro-holders — especially the equity investors and central banks that have bought significant amounts of euros since the currency’s inception in 1999 — could cause a major selloff.
The Federal Reserve loaned $1.032 billion to the ECB through the program it reopened earlier this month in response to strains in the global market for short-term dollar borrowing, the Wall Street Journal reports.
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