It is hard to find a currency pairing that had such divergent fortunes in 2016 than USD/EUR. From an economy that has surged, to a new president-elect that appears to be poised to make America great again for business, there have been plenty of reasons behind the surge of the US dollar. On the other hand, the Euro has been challenged by political turmoil all year long, as it has had to deal with one of its biggest members seeking an exit, as well as a spate of violent attacks by politically motivated individuals. Both of these factors have led to the American Dollar at making big gains against the Euro in 2016, with EUR/USD closing at 1.036 on December 20. There are a variety of influences that will come into play, which we will discuss in the paragraphs below.
The American economy is expected to strengthen in the new year
For the first time in many years, the American economy is in a strong and steady state. Job creation has been muscular throughout 2016, with the latest unemployment figures falling to 4.6% in November. This recovery has been on such a roll that Janet Yellen of the Federal Reserve has taken the extraordinary step of raising interest rates a quarter of a basis point to 0.5%. With strong hints from the Fed chairperson that further rate increases may be coming in the new year, it appears likely that the dollar will remain strong for the foreseeable future.
The policies of the Trump administration are expected to benefit the US dollar
The improving fortunes of the American economy is not the only factor that is expected to shore up the dollar, as the election of Donald Trump to the White House will come with its own set of benefits. The president-elect is set to put forth plans that will deliver significant tax cuts to citizens and businesses while increasing spending on areas such as infrastructure, both of which are expected to increase the value of the US dollar. Additionally, Trump's more ambitious plans to repatriate corporate cash from offshore tax havens and to replace free trade agreements with trade tariffs do their part to increase the value of America's currency should these initiatives come to fruition.
Anti-establishment sentiment to weigh on the Euro in 2017
On the other side of the pond, popular revolt in many European countries against establishment politicians will apply pressure to the Euro in 2017. The shocking Brexit results in June and the startling 'no' vote in the Italian referendum that was widely seen as a litmus test of prime minister Matteo Renzi's leadership are just a taste of what may lie ahead for Europe in the new year. With French president Francois Hollande, German Chancellor Angela Merkel, and interim Italian prime minister Paolo Gentiloni set to face voters in the months ahead, it is possible that they might all end up being replaced by populist politicians that are advocating for an exit from the European Union. Should this happen, it will have a chilling effect on the Euro, as pressure will mount in some of Europe's biggest countries to do away with one of the world's most prominent economic unions, undoubtedly sending its currency lower. Additionally, security concerns arising from a rash of terrorist attacks that have occurred across the continent in 2016 will apply pressure of its own, as fears of further incidents might take its toll on consumer spending and tourist arrivals in 2017.
Large account surpluses may buoy the Euro
While there is a chance that the US dollar and the Euro will reach parity in 2017 due to the factors discussed above, it may not happen due to the considerable underlying strength of the European Central Bank. According to analysts, current account surplus that the Eurozone holds is considerably higher as a share of GDP compared to when the Euro dropped to parity with the US dollar in 2002. Additionally, the same experts also feel that the technical advantages that the US dollar holds over the Euro have already been priced in by the post-election rally, leaving this currency pairing with little room to drop further than it already has.