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U.S. dollar-euro parity is a ‘multifaceted story,’ strategist says

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Wells Fargo Macro Strategist Erik Nelson joins Yahoo Finance Live to discuss the recent moves in the U.S. dollar, the euro, the Japanese yen, and other currencies.

Video Transcript

BRIAN CHEUNG: Think the parity that we saw between the euro and the US dollar, that's the first time we've seen that parity in 20 years. Now, Wells Fargo's Erik Nelson is among those that actually saw this coming. He joins us live on Yahoo Finance now.

Erik, great to have you on the program again. You had made the call for the euro to US dollar actually falling below 1 to 1. You made that call a few weeks ago. Just wondering what you see as the story behind that. Obviously, we know recessionary fears might be one reason why we've seen some outflows from euro denominated assets. But what's the bigger story here? Could you see that weakening even further?

ERIK NELSON: Well, Brian, at the end of the day, it's a very fundamental story. So you mentioned outflows from European assets. Partly a growth story as well with US growth staying quite resilient and fears of a deeper European recession somewhat imminently. I'd say the energy crisis and the cutoff of supplies from Russia to Europe of natural gas has really accelerated the move lower in euro and was one of the reasons we thought euro parity would happen so quickly.

It's also a central bank story. The Fed has continued to get more aggressive on inflation. They've dialed up the rhetoric and the actions, while the ECB has stayed fairly dovish. So this is a multifaceted story. And the last thing I'll say is, euro lower-- shorting the euro is not as crowded a trade as some may think. We think this move has another 5% to go, at least, over the next month or two.

AKIKO FUJITA: Another 5%. I mean, in terms of positioning then, how do you think investors should be looking at this?

ERIK NELSON: Well, what's really interesting is that as we were moving down toward euro, we saw a lot of interest from our clients-- I wouldn't say all of our clients, but some of them-- to start sort of fading the euro move lower, buying the euro on the dip. And I do think that that bias has to change for the euro story to change, because as long as there's not a lot of participation in the euro downside move, that means positioning is not as stretched as people think. So, again, this is one reason why we're still expecting more downside here over the next few months.

BRIAN CHEUNG: Now, for those that are watching and seeing the euro parity and saying, hey, this is going to be good for Americans traveling to Europe, it's the same story for those traveling to the United Kingdom. We've seen the great British pound weaken against the US dollar as well.

ERIK NELSON: Absolutely. I'm actually broadcasting from London here. And I can definitely confirm that the pound has gotten quite a bit cheaper. And it's everywhere. It's also Japan, the yen. Look at the yen. That's really been the weakest performing currency this year among the majors. So it's a broad dollar strength story. It's certainly, as you say, great news for US consumers traveling abroad. But the flip side of that, of course, is US exporters, multinationals, really feeling the heat here. And that's going to continue to be brought up on earnings calls, I suspect, over the next couple of months.

AKIKO FUJITA: Yeah, Erik, you highlighted the dollar-yen there. I mean, you talk about diverging monetary policy. The Bank of Japan certainly not even on the same page as the other major central banks right now. I mean, we keep hearing about yen moving towards 140 to the dollar. I mean, how close are we in-- what do you see? I mean, you saw the dollar-euro parity. What are you seeing in that cross?

ERIK NELSON: Well, you have two conflicting crosscurrents at the moment. On the one hand, you have a strong, assertive Fed versus a steady Bank of Japan, as you highlighted. At the same time, commodity prices coming down is helping the yen. And these recession fears are also helping the yen. But we tend to think that the energy rally has more to go here, both in natural gas and in oil.

So as long as the Fed stays pretty active and pretty aggressive, we do think the dollar-yen exchange rate is heading higher toward 140, probably higher over the next one to two months. My only sort of concern or question maybe would be, at what point does the Bank of Japan feel compelled to step in? I don't think we're there yet. And ultimately, it kind of comes down to the speed of the move. But I suspect another 3% or 4%, and they might feel compelled to act.

BRIAN CHEUNG: And then, Erik, lastly here, I want to ask if there are any blowout concerns here with the unprecedented amount of dollar strength that we've seen when you consider, you look at an episode like the '94 Mexican peso crisis, the '97 Asian financial crisis, where a strong US dollar led to global problems that central banks had to grapple with, do you see a risk of that right now?

ERIK NELSON: Absolutely, especially if this move continues for, again, another 5% or 7%. We're starting to see some more issues in emerging markets. The Chilean peso not one that's as closely followed as the Mexican peso, but has really been essentially collapsing.

I do see a greater risk of this type of thing, given the extent of reliance on US dollar financing across emerging markets. To put it in the simplest terms, Brian, when the dollar rises very quickly, things tend to break in the global economy and the global financial markets. So this is going to continue to be a story not just for FX markets, but the broader market as well.

BRIAN CHEUNG: All right, Wells Fargo senior macro strategist, Erik Nelson, thanks so much for joining us. Appreciate it.