Euro Forecasts 2016: BofA See EUR/USD at 0.95 in 2016

Bank of America Merrill Lynch Global Research have repeated their predictions for the EURUSD to fall below 1.0 in 2016, however they warn of near-term strength in the shared currency continuing.

According to BofA Merrill Lynch Global Research, 2015 was the year the EUR finally weakened and 2016 will see a continuation of the EUR’s downturn.

In a new note the Bank’s strategists however warn, “we remain bearish on EUR, but expect the path to remain choppy."

In fact, the prospect of further short-term euro gains from present levels remain elevated.

“We project the EUR/USD to weaken to 0.95 by end-2016. At the same time, our year ahead top contrarian trade is for short-term EUR/USD upside.

“This suggests upside Euro risks in the short term, but still negative for the medium term.

“Our preferred bearish EUR trades are actually against non-USD crosses, particularly SEK and JPY.”

In the bank’s view, the European Central Bank (ECB) policies and credibility can have implications for the EUR.

Subsequent to the ECB’s early 2015 stimulus package, the bank gained market credibility but a great deal was wiped away after they were blamed to have fostered and then failed to live up to high-expectations of an aggressive end-of-year monetary stimulus package.

So in 2016, BofA Merrill Lynch advises,

“Euro bears should be patient with the ECB in 2016.”

More evidence of below-par Eurozone inflation is needed before markets begin pricing in more QE, and this may take the first six months of the year.

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Don’t Sell the EUR Just Yet

However, the bank cautions, “Don’t sell the Euro yet.”

There are indicators that denote upside EUR risks in the short term.

The markets remain short EUR, and are also long Eurozone equities.

The long Eurozone equities position is an FX-hedge to take advantage of upside EUR risk.

Additionally, BofA Merrill Lynch Global Research says,

“High frequency data could justify a stronger Euro.

“We don’t expect more easing from the ECB during most of the first half of the year, while it could take equally long for the market to form a view on the Fed’s hiking pace.

“However, we would also expect the ECB to push against a strong EUR.”

EUR to End 2016 on a Low Note

BofA Merrill Lynch expects EUR to end on a low note in 2016, forecasting that EUR/USD will weaken to 0.95.

The Bank reasons, “Although our EUR/USD equilibrium estimate is 1.16, the estimate drops to below parity if we take into account the large difference in the output gaps between the Eurozone and the US.

“The Eurozone inflation risks remain to the downside compared with the US.Even though the ECB disappointed in December, we do not expect it to stop QE before inflation is on a clear path towards their target. 

“Rate differentials and aggregate data point to a weaker Euro. And we expect the PBOC to be more willing to accept a weaker Euro, as it allows more CNY flexibility.”

Of their FX strategy, BofA Merrill Lynch says, “Unless we see much stronger US data or US inflation, we would not be outright short EUR/USD and would only sell EUR rallies. It is not an optimal currency area.”

Additionally, the Bank sees two long term challenges for the ECB.

Firstly, the markets “could test the ECB’s commitment to QE if we see inflation divergence between Germany and the rest of the Eurozone, squeezing the Euro higher.”

Secondly, “a periphery sell-off as the ECB approaches its inflation target and the market starts pricing the end of QE could bring crisis risks back and keep the Euro weak even post-QE.”

For BofA Merrill Lynch, either of these could trigger more EUR volatility if and when the ECB addresses them, maybe at the end of 2016 or early 2017.