What would the USD/EUR exchange rate be without the euro-zone sovereign debt crisis?
The sovereign debt crisis in the euro zone has clearly weakened the euro’s exchange rate, with fluctuations resulting from the varying level of investor concern with regards to the outcome of this crisis.

Yet many factors should contribute to a weakening of the dollar:

-

excessive monetary creation in the United States; substantial fiscal deficit in the United States and the prospect of a sharp rise in public indebtedness;

-

external deficit of the United States; appreciation of the RMB against the dollar, which means that China is reducing its purchases of dollars.

We seek to ascertain what the USD/EUR exchange rate would be without the euro-zone sovereign debt crisis. We show that it would be above 1.60 (precisely 1.63).

ECONOMIC RESEARCH Author: Patrick Artus

The euro-zone sovereign debt crisis and USD/EUR exchange rate

The sovereign debt crisis in euro zone (of which we represent the intensity by the weighted average sovereign CDS of the countries in difficulty) has clearly weakened the euro in relation to the dollar since the start of 2009 (Charts 1A and B).
Chart 1B Em pirical correlation betw een sovereign CDS* and USD/EUR exchange rate 400 1.0
* Count ry CDS: Spain + Portugal + Greece + Ireland + Italy weight ed by size of public debt Sources: Dat astream, Bloomberg, Nat ixis

Chart 1A Exchange rate and sovereign CDS
USD/EUR exchange rate (LH scale) 5-year CDS: Ireland + Greece + Port ugal + It aly + Spain (in bp, RH scale)

1.6

1.0

1.4

300

0.5

0.5

1.2

200

0.0

0.0

1.0

Sources: Dat astream, Bloomberg, Natixis

100

-0.5

-0.5

0.8 02 03 04 05 06 07 08 09 10 11

0

-1.0 05 06 07 08 09 10 11

-1.0

The correlation between the USD/EUR and sovereign CDS has become, on average, strong (and negative) since the second half of 2008. Yet many factors should have weakened the dollar However, the