Euro-Dollar to Smash Through 1.20 Barrier Predicts Nordea
- Written by: Gary Howes
Image © Adobe Stock
An outright bullish call on the euro-dollar exchange rate is sounded this Friday.
The dollar faces a renewed period of weakness as global investors begin to shift capital away from U.S. assets, while the European Central Bank is poised to raise interest rates on at least four occasions.
These are the predictions made by Nordea Bank, the Scandinavian lender and investment bank, which is in a new research and forecast update this Friday.
In it, analysts say the recent bout of dollar strength linked to the Iran conflict is already fading, with the currency now trading back near levels seen before the U.S. attack.
Pairs like EUR/USD and GBP/USD have steamed to pre-war levels, and Nordea says the reason is a renewed selling of the dollar, which has roots beyond geopolitics.
These drivers will stay in place.
"Dollar weakness over the coming years will, in part, be driven by a reallocation away from US assets and towards other investment opportunities," Nordea says.
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At the centre of that shift is the U.S. Treasury market: The U.S. is expected to issue large volumes of debt to fund public spending, but Nordea warns that demand may not keep pace.
“Attracting sufficient demand for the volume of issuance ahead may prove increasingly challenging,” warn analysts.
That challenge is being compounded by changing dynamics abroad as Europe and Japan, traditionally large buyers of U.S. Treasuries, are now expected to increase domestic spending significantly, particularly on defence and infrastructure.
Above: The charts suggest the euro-dollar can expect some near-term consolidation after a strong run.
This implies more local bond issuance and less capacity to absorb U.S. supply.
“An increased supply of government bonds in the global market could make it more difficult for the US government to place this debt,” the bank says, pointing to the risk of “a weaker dollar and higher Treasury yields.”
Don't let the rate decide.
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Confidence is another factor as Nordea says “confidence in the US government has not improved in recent weeks – quite the opposite,” adding to the case for a gradual shift in global capital flows.
Monetary policy divergence is also moving against the dollar with the Federal Reserve expected to keep rates unchanged as the European Central Bank is seen tightening, creating a classic divergence in favour of euro-dollar upside.
“We expect the European Central Bank to deliver four rate hikes… while the Federal Reserve is likely to keep rates unchanged.”
That would narrow interest rate differentials, removing a key pillar of dollar support.
A smaller rate gap also changes investor behaviour.
Nordea says a reduced differential “would lower the cost of hedging US assets,” encouraging investors to hold U.S. securities without taking on dollar exposure.
“As a result, purchases of US assets may no longer be accompanied by corresponding demand for the dollar.”
Nordea Markets forecast euro-dollar at 1.25 by the end of the year, with 1.22 being achieved as early as mid-year.
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