EUR/USD Surprisingly Strong as USD Index Forecast to Strengthen 5% by End of 2015

Barclays are forecasting the EUR/USD exchange rate to fall below parity in 2016.

The EUR/USD pair remains towards the top of a familiar range defined by 1.1090 providing support, with resistance lying at 1.1285-1.1345 seen blocking any extensive strength.

Indeed, persistent euro strength appears to be one of the defining factors on global markets as we look to close out September.

"We are somewhat surprised at the EUR strength considering current events are only likely to put further pressure on the ECB to instigate a further stimulus package. We are watching price action closely in EURGBP as it has rallied into important resistance in the .7400-.7500 region, with EURUSD in a similar resistance zone up to 1.1375," note Lloyds Bank in a daily comment piece to clients.

Should the sideways range break it will most likely be lower suggests a new analysis from a leading institutional researcher.

Barclays expect the euro / dollar exchange rate will continue weakening on the policy divergence between the US Federal Reserve and the European Central Bank.

“After the August risk-off, EUR strength has left the currency close to fair in REER terms. We expect the ECB to respond by committing to an extension of its QE program imminently, and continue to retain a dovish bias for the foreseeable future,” say Barclays in a note to clients.

QE Plus on the horizon

ABN Amro share Barclays' view on extending the QE programme describing the outcome as their base case. 

"The ECB will step up its monthly asset purchases by EUR 20bn to a total of EUR 80bn. At the same time, we expect that the QE programme will still continue to run up to September 2016, although extending the programme beyond this date is still an option as well. The expansion of the QE programme will come before year end," say ABN Amro.

The Barclays forecast now calls for the EUR to weaken by more than 10% in REER terms over the next 12 months.

“Meanwhile, despite the delay in Fed lift-off, the USD remains the only large currency that faces a hiking cycle over the next few quarters, and is likely to strengthen in real exchange rate terms,” says the Bank.

At the time of writing the euro to dollar exchange rate (EURUSD) is trading at 1.1151 - well within its short- to medium-term range.

US Dollar to Strengthen 5%

Barclays analyst Jose Wynne says he continues to forecast a stronger US dollar, which his team expect to appreciate over 5% in REER over the next 12 months.

The increase comes despite any delay to the US Fed’s lift-off on interest rates. What matters is that rates will move higher over coming months, regardless of the starting date.

At the same time the analyst expects the EUR to continue to be investors’ preferred short.

“The recent moves in FX crosses have left the EUR REER only 4.5% cheap relative to fair, and we look for EUR REER to depreciate another 11% in the next 12 months,” says Wynne.

The ECB is ready to expand its QE program imminently, pressured by weaker global growth, a softer inflation outlook, and tighter domestic financial conditions.

“We forecast EURUSD at 1.03 by year-end and 0.95 in 12 months. We expect the CHF to attract attention, as we see the uptrend in EURCHF as being sustained,” says Wynne.

Note that Barclays have revised their EURUSD forecasts up to 1.03 and 0.95 for year-end and in 12 months, respectively, but maintain the view of significant further downside risk

Potential Quantitative Easing Extension at the ECB

Market measures of medium-term inflation expectations have also fallen in Europe, below the level of August 2014, when ECB President Mario Draghi first flagged the prospect of euro area QE.

“The fact that inflation expectations have returned to such low levels even after the announcement and implementation of the ECB’s QE program is a policy problem for the ECB that will, we think, result in an extension of the existing program before year-end,” says Ajay Rajadhyaksha, Head of Macro Research at Barclays in New York.   

However, unlike in the past, it is unclear how aggressively central bankers will be inclined to respond.

The ECB has an easier job; there is enough labor market slack, and euro area inflation is low enough that Barclays expect the ECB to extend QE by six more months, to March 2017, with an announcement likely in October.

When combined with the view that the US Fed will be raising rates we can see why the downside strategy is preferred in EURUSD.