The euroThe is approaching parity U.S. dollarFor the first time since 20 years, currency strategists disagree on how the country will achieve that goal.

On Thursday, the euro hovered at $1.05 in Europe. This is after almost one year of steady decline, which was around $1.22 per month last June. This week, the common currency fell to just over $1.03.

Risk aversion on the markets has helped to strengthen the dollar. Investors have shifted towards traditional assets as “safe haven”, with concerns over Russia’s invasion of Ukraine and surging inflation.

Divergence among the central banks’ monetary policies has contributed to the narrowing of differences between currencies. These are the U.S. Federal ReserveThis was earlier in the month raised benchmark borrowing rates by half a percentage pointAs it seeks to control inflation at its 40-year peak, the government will announce its second major increase for 2022.

Fed Chairman Jerome Powell said on TuesdayThat the central bank would not hesitate to keep raising rates until the inflation rate is down to manageable levels and that he will continue his pledge to help it get closer towards the Fed’s goal of 2%.

Contrary to both the Fed and Bank of England the European Central Bank has not raised interest rates, despite high levels of inflation in the euro area. It has however signaled that it will end its asset purchasing program, and policymakers are now more hawkish.

Francois Villeroy de Galhau (ECB Policymaker) stated on Monday that an excessive euro weakness threatened price stability in the bloc. He said that this would raise the cost of imported dollar-denominated commodities as well as fueling inflation that has pushed the euro area to new record heights.

How do you get to parity?

CNBC’s Sam Zief was the global head for FX strategy at JPMorgan Private Bank. He stated that to achieve parity, there would need to be a reduction in growth expectations in the euro zone relative to the U.S. (akin to what happened in the immediate aftermath to the invasion of Ukraine).

Is it possible? Zief replied, “Is that possible?”

He suggested that the risk-reward over a two to three-year period — with the ECB likely escaping negative rate territory and fewer fixed income outflows from the euro area — means the euro looks “incredibly cheap” at present.

Zief stated, “I don’t believe there are many clients who will look back in the next two-to three years and decide that buying euro sub-1.05 was a bad decision.”

Stephen Gallo (European head of FX strategy for BMO Capital markets), noted that Fed’s aggressive interest-rate hiking cycle, and subsequent quantitative tightening, are both already priced into dollars.

CNBC also received an email from Gallo stating that the EURUSD pair will be affected by the possibility of material policy differences between the Fed (ECB) and the Fed.

He said that it was also the development of the EUR’s central balance of payments flows and the possibility of further negative energy supply shocks which have also been dragging down the currency.

According to our data, we have not observed any sign of EURUSD short positions due to leveraged funds. We believe this is a result of weak underlying flows.

Gallo stated that a move to parity in euro/dollar would require ECB’s “policy inertia” in the summer. That would include rates staying unchanged and a total German embargo of Russian fossil fuel imports. It would also lead to energy rationing.

If the central bank faces the worst combination of high unemployment in Germany, higher prices and increased recession risk (i.e. Gallo warned that stagnation is a possibility.

“For the Fed’s role in this whole thing, I believe that the Fed would become alarmed if EURUSD moved to 0.98-1.02 range. With USD strength at this level vs EUR, I could see EURUSD moving to this region, causing Fed to slow down its tightening campaign.”

Dollar ‘too high’

In a Tuesday note, the dollar index has risen by 8% over the past year. Deutsche BankThe “safe-haven” premium for risk priced into the greenback is now at “the upper end of extremes”, even after accounting for interest rates differentials.

George Saravelos is the Deutsche Bank Global Head of FX Research. He believes that there’s a turning point. According to him, we now stand at a point where any further decline in financial conditions would “undermine Fed tightening expectations”, while there is still a lot of tightening for Europe and the rest.

“We don’t believe Europe is about to enter a recession and European data – in contrast to the consensus narrative – continues to outperform the U.S.,” Saravelos said.

Deutsche Bank’s valuation monitor shows that the U.S. Dollar is the world’s most valuable currency. However, the foreign exchange positioning indicator from the German lender indicates that long dollar positions against emerging market currencies have been at their highest level since the height of the Covid-19 pandemic.

Saravelos stated that all of the above messages convey the same message, namely the dollar is too expensive. According to our forecasts, EUR/USD should rise back to 1.10 in the coming months and not drop to parity.

Parity: The Case

Although many market participants remain skeptical of parity being achieved, at least for the time being, there are still pockets that believe the euro may weaken.

Interest rate differentials vis-à-vis the U.S. shifted against the euro after the Fed’s June 2021 meeting, in which policymakers signaled an increasingly aggressive pace of policy tightening.

Capital Economics’ senior markets economist Jonas Goltermann stated last week in a note that the ECB’s latest hawkish shift had not matched Fed expectations or been sufficient to counter the rise in euro-zone inflation anticipations since 2022.

Capital Economics anticipates that the Fed’s policy will be the same as that of the markets. However, Goltermann believes the ECB will take a more conservative than expected path. That would mean a smaller shift in nominal interest rates against the euro.

Deteriorating euro zone terms of trade and a global economic slowdown with further turbulence ahead – with the euro more exposed to financial tightening due to the vulnerability of its periphery bond markets – further compound this view.

“The upshot is that – contrary to most other analysts – we forecast the euro to weaken a bit further against the dollar: we expect the EUR/USD rate to reach parity later this year, before rebounding toward 1.10 in 2023 as the headwinds to the euro-zone economy ease and the Fed reaches the end of its tightening cycle,” Goltermann said.