ECB Banks to Drive EUR/USD Rate to Parity Forecast Morgan Stanley

Stay wary of the dramatic turnaround in fortunes for the euro argue Morgan Stanley who confirm they still see a decline to 1:1 against the dollar.

The euro has powered higher in the wake of the US dollar's broad-based capitulation following the US Federal Reserve's paring back of plans to raise interest rates in agressive fashion this year.

Further impetus to the move higher was provided by a sell-off on the Germany stock exchange, a scenario which tends to benefit the euro.

The rally has taken the EUR/USD above 1.13 and we are now at the best exchange rate for dollar buyers since February.

With momentum as it stands there is little reason why the exchange rate cannot take out the best levels since October 2015 over coming days.

Latest Pound/Euro Exchange Rates

	Live: 1.1444▲ + 0.01% 12 Month Best: 1.2162
*Your Bank's Retail Rate	1.1055 - 1.1101
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* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

The Euro is Forecast to Fall to Parity Against the US Dollar

US investment bank Morgan Stanley have meanwhile reiterated their call for the EUR/USD to reach parity by the end of 2016.

There was a time when expectations for the euro to hit 1:1 was the norm but as 2015 proceeded we saw some notable backtracking.

Most famous of all will have been the admission by perma-bears Goldman Sachs, who previously had called for EUR/USD to fall to a sub-parity 0.95.

However, after an embarrassing backstroke Goldman Sachs had to accept that a move to parirty and beyond was too bearish and raised their forecast in December 2015 to 1.05.

Goldmans admitted to have “badly misread” the ECB ahead of its rate meeting. 

However, Morgan Stanley are sticking to their guns on parity, and because they are out of consensus we are taking notice!

Concerns about the rising balance sheet exposure of Euro-zone financial institutions, who have greater ratio of non-performing loans compared to non-European brethren is a major factor in Morgan Stanley’s fresh downward revision.

Add to this the impact on tight bank margins caused by the ECB’s negative rates policy, as well as a general lack of credit transmission to the wider economy and you have the perfect storm brewing for the euro:

“Outside JPY, CHF, USD and SEK, it is hard to find a positive currency story. In fact, the outlook has weakened further in some cases, such as GBP and EUR.”

Global Money Tight

Morgan Stanley's analysis assumes a backdrop of constrained global liquidity conditions, caused by repatriation of yen by Japan and a rising dollar, which are likely to make, “creditors more selective about where to place their funds.”

In such an environment Euro-area banks will come up for closer inspection and may be found wanting:

“We think that FX investors will start to become more concerned about the large balance sheets in the European banking sector.”

Banks Face Multiple Headwinds

Whereas during the peripheral debt crisis of 2011 the weight of non-performing loans on the books of euro-zone peripheral banks were the central concern, this time it is not so much a question of bad loans alone but rather a poisoned cocktail of narrowing credit spreads due to ECB’s negative rates, a lack of willingness to lend to the wider economy and the legacy of bad loans altogether:

“This time it is not so much the asset outlook that concerns EUR traders. Instead, it is the capacity to fund large balance sheets, the impact on bank credit spreads, and the ability and willingness of banks to provide credit that may send EUR lower, in our view.” Says the Morgan Stanley note.

This has informed their most recent forecast for EUR/USD to fall to 1.06, 1.03 and 1.00 at the end of Q’s two, three and four respectively.

ING: Euro Now Overvalued

Backing Morgan Stanley's stance on the euro needing to head lower is ING's Petr Krpata who says this strength in the euro is an overreaction by markets. 

"Eventually, we are likely to see a modest retracement towards the 1.10/1.11 level when the initial overreaction fades (we currently identify EUR/USD as being 1% overvalued) and risk remains bid, but a decline below this level needs an active catalyst from the USD side," say Krpata.

Nevertheless, traders should allow the move higher to extend for some time yet.

Krpata reckons the higher-yielding currencies, such as the Aussie dollar are likely to benefit moreso than the euro.

The improving US data yet the Fed’s cautiousness not to imply an overly steep path of rate hikes, as indicated by the dotted diagram, "should be good news for risk assets in coming weeks, at least until the run-up to the April 27 Fed meeting," says Krpata.

ING expect G10 FX high yielding and commodity FX to do well for time being  (AUD, CAD).