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EUR/USD: Bank of America and Morgan Stanley Look for Bulls to Awaken from Slumber 

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- EUR/USD on course to recover 2018 losses say two FX heavyweights.

- Fed shift to drive USD supply higherand value lower - Morgan Stanley.

- US GDP to slow as Europe stabilises, lifting EUR/USD - Bank of America.

Europe's single currency is on course for large gains this year, according to analysts at Bank of America and Morgan Stanley, who say they're anticipating a 2019 demise of the U.S. Dollar rally that has the kept the euro on its back foot for the last 12 months.

The U.S. economy will slow this year following a vintage year in 2018 while the Eurozone economy should stabilise in the wake of a torid few quarters for the continent, according to Bank of America, which will have significant consequences for the market's view of the relative interest rate outlook.

"EUR weakness is fully consistent with data, but we continue to expect stronger EURUSD year-end," says Athanasios Vamvakidis, a strategist at Bank of America. "We see early signs that data and flows are turning for the EUR, but Brexit and US-EU trade tensions are still short term risks."

It was an exceptional economic performance last year that enabled the Federal Reserve to lift its interest rate four times even as other central banks were sidelined by slowing growth and fears over what the U.S.-China trade war might mean for their economies further down the line.

This policy divergence powered the greenback to a near-5% gain last year and the Euro-to-Dollar rate toward a near-5% loss but if the U.S. economy has now turned a corner the greenback could be looking at a much less exciting few quarters ahead of it. 

Early indications are that the U.S. economy has shifted into a lower gear this year. Retail sales growth slowed in January and jobs growth as detailed by the February nonfarm payrolls survey nearly ground to a halt. Inflation has also softened and business investment is falling too. 

"This could squeeze the market's short EUR position higher," Vamvakidis says. "We also believe that the impact of data on EUR could be asymmetric, stronger on a positive surprise. Despite our constructive EUR view for the rest of the year, we see two risks in the short term."

Above: Euro-to-Dollar rate shown at daily intervals. March 14, 2019.

Eurozone GDP grew by 1.8% in 2018, down from 2.4% the previous year, while quarterly growth halved from 0.4% to 0.2% during the final six months of the year. Germany avoided recession by just a whisker and many forecasters still project a dire year ahead for both economies.

Vamvakidis says a so-called no deal Brexit would be "a severe shock" for the Eurozone economy and that a trade war with the U.S. would also have a severe negative effect on the bloc. The threat of either of these happening will keep the Euro weighed down for now but the bank forecasts that by the end of June the Euro-to-Dollar rate will have risen from 1.12 Friday to 1.20 and that the exchange rate will hit 1.25 by year-end. 

Morgan Stanley also has a bullish view of the Euro although this is a symptom of its bearish outlook for the Dollar. It's rare-if-not-impossible for both the greenback and Euro to rise at the same time given the large share of global currency flows taken up by the two units. 

"Unlike in early 2018, investors this year seem to have turned EUR-bearish,expecting USD to maintain its bullish outlook at least against low-yielding currencies," says Hans Redeker, Morgan's head of FX strategy. "It's the USD side of the equation that primarily drives our EURUSD bullishness."

Above: Euro-to-Dollar rate shown at weekly intervals. March 13, 2019.

Put differently, Redeker says the Dollar's decline will be the result of actions taken by the Federal Reserve in 2017 and early in 2019. In 2017 the central bank stopped reinvesting the money it gets each time a federal government on its balance sheet matures. 

The Fed's balance sheet swelled from less than $1 trillion to more than $4 trillion between 2008 and 2015 as it bought huge piles of U.S. debt in an effort to lift inflation by stimulating the economy with lower market-based interest rates. 

Those earlier reinvestments had ensured a steady supply of Dollars was drip fed into the U.S. and international financial system. However, the decision to stop reinvesting the proceeds of maturing bonds has since created a shortage of U.S. Dollars on international markets. 

The Fed said in January it will be slower to raise rates this year because it wants time to observe future developments in the global economy, given a slowdown overseas could easily undermine U.S. growth and inflation prospects.

That, much like the Fed's other interest rate policies, has had far-reaching consequences for economies and currencies the world over in the last year or more. But the Fed backed away in January 2019 from its commitment to shrinking its balance sheet, easing the liquidity constraint previously imposed on the financial system

"These changes in liquidity conditions can also help to explain changes in USD. We appear to be approaching an inflection point where the previous pullback in liquidity tightness passes through to USD weakness – to the tune of 10% in the Dollar index," Redeker says. "We remain EURUSD bullish." 

Redeker forecasts a Euro-to-Dollar rate profile that is similar to that put forward by Bank of America for this year. He says the Euro should hit 1.17 against the Dollar by the end of June and 1.25 before the curtain closes on 2019.

The Euro-to-Dollar rate was quoted 0.11% higher at 1.1319 Friday but is down -1.27% thus far in 2019. 

 

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