A new currency forecast for 2015 / 2016 from Barclays suggests that the euro exchange rate complex will continue to under-perform and EUR-USD will ultimately be driven below parity.
Insight on EUR strength: It is all about European bonds at the moment. The fall of German bund prices and rise in bund yields has been matched by a rise in the euro - investors have been dumping bonds owing to pathetic yields. If this continues the euro could stay stronger for longer.
Currency trading strategists at Barclays have suggested speculators should look to profit on impending declines in the euro v dollar exchange rate.
The call comes after the exchange rate has enjoyed a period of gains, rising from a low point of 1.0462 back in March to a best of 1.1392 in May. The recovery higher should however be viewed within the prism of a longer-term downtrend for the pair and as such many in the market view this improvement as being temporary at best.
It is believed that current levels (euro to dollar exchange rate conversion @ 1.1222 at the time of writing) offers a good opportunity to profit on a return to at least 1.0460. Speculators have been advised that should the euro exchange rate complex strengthen and push the EUR-USD back to 1.1680 then the trade should be abandoned.
“Technically, momentum divergence on the daily plot signals topping risk and room for a move lower in range. Breaking back below former range highs near 1.1055 would add to our bearish conviction,” says Jose Wynne, the analyst at Barclays who authored the tactical recommendation.
The Recovery in the Euro Exchange Rate May Have Over-Extended
There are two elements to the euro v dollar exchange rate recovery – on the USD side weakness has been inspired by disappointing data releases which saw the trade-weighted USD more than 4% lower from its mid-March highs.
By contrast, the EUR has recently rallied, largely aided by, “better-than-expected euro area economic data, incremental optimism related to Greece’s negotiations and the partial unwind of ECB QE-related trades, which has pushed European nominal yields to year-to-date highs,” note Barclays.
We would view any further improvement in yields as being the single most dangerous development that could push the euro to dollar exchange rate higher. Indeed, on the 12th of May the sell-off gathered pace with a vengeance pushing the euro up by nearly a percent against the dollar.
“While the euro area rates sell-off may have some fundamental justification, we are convinced that the move has overextended and was exacerbated by the combination of positioning and market liquidity issues,” says Wynne.
Barclays believe the Eurozone faces significant headwinds and that the EUR downtrend ultimately remains in place believing that persistently low expected returns to capital and the ECB’s commitment to a long period of low (or negative) interest rates augur for a much lower EUR even if the bottom is revised up or delayed in time.
“Thus, we believe that the EUR has much further to go in its trend depreciation, albeit at a slower pace and with higher two-way risks attached. Moreover, we still think the EUR faces risks from a prolonged period of Greek political uncertainty,” says Wynne.
As a result, the British bank expects the downtrend to resume despite the recent rise in euro area yields, which are considered to be a healthy positioning/liquidity-led correction rather than a fundamental change in the outlook.
But Westpac are Buying the Euro
Australia's Westpac argue that selling the euro dollar now is premature and argue that a test of 1.15 remains preferred. In their latest 'High Conviction FX Trades' briefing the bank confirm they remain long EUR from 1.1142 as of the initiation of the call back on May 5.
"EUR may have one more chance to run at 1.14-1.15 before the topside move is completely exhausted and long term shorts step up to the plate. Note that all our model signals are bullish EUR – higher bund yields drag up our EUR total yield signal, better data trends of late give the region a positive growth signal, higher oil prices boost the currency’s rating in our logit signal while the region's still very healthy external surpluses keep our current account momentum model firmly bullish EUR too," says analyst David Coloretti.
Looking at the longer-term picture we continue to see a broad consensus amongst analysts that at some stage the decline in the EURUSD will recommence. While not all are predicting parity in the exchange rate even the most optimistic forecasts are pricing in 1.04 once again.
Barclays are more bearish though. “While we acknowledge upside risks, we continue to forecast EURUSD to reach 0.98 at the end of December 2015 and 0.95 at the end of March 2016 as the US recovery regains momentum,” says Wynne.