On July 15th, 2002, the value of the Euro dipped below one US dollar. For the very first time 20 years later, the US dollar is at parity with the Euro, meaning that $1 = €1.
Ever since we started living in “unprecedented times”, it seems like there have been a string of events plunging the economy into more chaos.
We’ve endured a life-altering pandemic that severely changed how business is conducted. We’re currently witnessing a devastating war in Ukraine, massive supply chain issues, sky-rocketing fuel prices, economic bankruptcy in Sri Lanka, and the highest inflation in 40 years.
The latest development with the plummeting value of the Euro has left many wondering about the meaning of it all, and more specifically: how it affects businesses. This article aims to bring you up-to-speed on the how and why of the EUR/USD parity, and what you can do to prepare for the future.
What is the EUR/USD parity?
The EUR/USD parity is a state of currency exchange rates where the Euro and the US Dollar have the same value. In short, you can buy one Euro by spending one US Dollar, and vice versa.
In forex trading, traders invest in a currency that they believe will trend upwards based on economic policies and political climate. In this case, traders will move away from buying Euros and focus their investments elsewhere.
Foreign exchange rates directly affect purchasing power, trade, and financial markets. This eventually trickles down to individuals in an economy through cost of living, wages, and quality of life.
How did the Euro drop to near parity with the US Dollar?
Several factors are at play as the reasons behind the Euro - Dollar parity:
- Europe is facing an energy crisis due to high oil prices and a reduction in Russian natural gas supplies caused by the war in Ukraine
- Eurozone inflation hit an extremely high 8.6% while US inflation has reached 9.1%
- To combat inflation, banks of top economies including the US and the UK have increased interest rates in an effort to curb excess spending
- The European Central Bank (ECB) has confirmed the first increase in interest rates in 11 years, to respond to 4X the target inflation rate, and suggests yet another hike later this year
The cost of energy is up 41%, increasing the cost of food, housing, and travel: the very elements that were supposed to help recover from the effects of COVID on the economy. In short, instead of the expected bounce back from the post-pandemic economy, Europe (and the rest of the world) is now facing a likely recession in 2023.
What does the EUR/USD parity mean for the economy?
In the short term, the Euro is predicted by macro-economists to either drop further, or stay close to parity against the US Dollar. This translates to a period of recession for the Eurozone in the long term, around 2023 or even earlier.
Overall, the EUR USD parity benefits American companies importing goods from Europe, but is not the best news for European companies purchasing from the US. In the broader scheme of things, companies generating revenue in USD with operations in EUR stand to benefit.
In volatile circumstances such as these, investors and economies become more risk-averse. The tendency will be to invest only in the safest of currencies - the USD. This is exacerbated by the latest news of Russia threatening to cut off energy supply to Germany.
As governments channel energy supply away from industrial sites towards more compelling needs of the region’s constituents, industrial growth will likely slow down. Even for companies within the US, exports will suffer as overseas sales drop. Although the tech industry is not impacted to the extent of energy intensive or manufacturing industries, a slow-down can still be expected.
How to adjust your financial strategy for further economic slowdown
For multinationals earning revenues in EUR, the outlook appears poor as the value of income generated drops with the Euro. As well, an increase in buying power is less meaningful when it comes with decreased ability to produce goods for purchase.
With an inevitable slow down, a few themes commonly appear for businesses in times of recession, including risk-averse decision making, slowed growth, and increased due diligence. To adapt your financial strategy to fit these themes, consider implementing the following changes:
Pace your growth
You can achieve this with an increased concentration on being data-driven: for example, when launching into a new market, place more effort on your launch and market strategy
"It's not about stopping growth, it's about making sure that growth is being articulated in the right place." - Thuy-Vy Mai, FP&A and Investor Relations, Pigment
The importance of strategic and planned growth is especially important in the current climate mainly due to the high cost of rectifying wrong decisions. Reversing the damages of launching in a market with poor fit, for example, involves expensive and time consuming efforts such as rehiring people and recouping lost investments.
Costly mistakes in the urgency to grow are best avoided by methodically evaluating risks, planning for unpleasant surprises, and investing in the best technology and data.
Push towards profitability and ROI measurement
By placing an increased focus on capital efficiency, companies bring in a long-term strategy for sustained growth, profitability, and bigger impact from each dollar of spending. It's a best practice to keep track of profitability and ROI metrics, but you need the right tools and the right datasets. It's crucial to have the most accurate and up-to-date sets of data.
"While internal benchmarking and checking your performance against your budget is great, you also need to look externally at how you compare with other companies in the market."
The right KPIs and datasets help make the right internal and external decisions, as well as sharing your performance with current and future investors. As tough economic times continue, investors will continue placing an increased focus on data and due diligence.
“Investors will want to know that your current performance is not sugar coated, to make sure what you're selling them as an equity story is true.”
Review your headcount allocation
While the current times call for somewhat slowed hiring, what’s more important is reflecting on your hiring decisions and how to best nurture the talent your organization currently houses. One of the key measures to take is measuring and enabling productivity, through sufficient support, career and skills development, and personalized goals.
"Even with the most senior, highly specialized experts, wait until they're fully ramped up and at full capacity before hiring additional talent."
Take the time to review if your hiring plan makes sense, nurture the talent, and then identify the levers of productivity and efficiency rather than just cutting your budget.
Tightly monitor spending
"...super important to get all teams aligned on the strategic goal if that goal is to be more cautious in spending."
Inevitably, economic downturns call for tightened spending. While making the most of what you have or being more creative about spending, it's important to align your teams. Tools like Pigment play the role of a collaborative platform for teams to come together to make decisions based on data, with exceptional visualization and collaboration features.
Fine-tune your currency swap strategies
Usually, bigger corporations have treasurers involved in currency swaps. These professionals monitor foreign exchange rates and advise on general currency value trends. Certain maneuvers in this regard can be helpful, for example:
"When you craft a contract with a certain price, you lock that price so even if the value goes down in the future, you've locked in the value. It's a good way to protect from foreign exchange fluctuations."
CFOs are business partners to lead through economic downturns
Across each of these themes, it’s easy to see the increased importance of Strategic Finance teams and CFOs. Now more than ever, CFOs should be working side-by-side with CEOs as business partners to pivot a strategy more suited for tough economic times with no sign of slowing down.
Slower growth doesn’t have to mean a complete shutdown of growth initiatives or a full stop on hiring. While it’s prudent to shift to a scarcity mindset, this phase can be an opportunity in disguise for inward reflection.
Now’s the time to double down on nurturing and developing your existing workforce. For example, did you know that >60% of CFOs feel a massive skills gap in business partnership amongst their teams? This slow down could be a unique opportunity to upskill teams with the technical and soft skills needed to be a strategic business partner.
Additionally, scenario planning has emerged under the limelight as a crucial activity for companies to prepare for the future. Our practical guide to scenario planning is a great place to start discovering how scenarios can help make better decisions with confidence.
In conclusion, as Ajay Vashee, General Partner at IVP and ex-Dropbox CFO states about the market downturns,
“Market environments are not in the hands of the CFO. What you can control is your execution and progress towards your vision, category ownership, and market ownership.”