The discount to fundamental value carried by the Euro-to-Dollar rate is growing wider and upside risks around the currency pair are mounting as year-end approaches.
The Euro is still undervalued relative to the US Dollar, according to strategists at Credit Agricole, who have raised their estimate of fair value for the pair and are saying traders should buy the single currency on dips.
Taking into account recent strong data and the European Central Bank having begun a slow and steady walk toward the exit of its quantitative easing (bond buying) program, Credit Agricole has nudged its EUR/USD forecast higher.
“After the ECB announced the details on tapering we believe markets will turn their focus to data as a market driver,” says Valentin Marinov, head of G10 fx strategy at Credit Agricole. “Both growth and inflation may continue to improve and that should keep risk assets supported too.”
October’s eagerly awaited announcement that quantitative easing will be curtailed has triggered “only limited downside” while helping to keep risk sentiment stable.
The ECB said Thursday it will reduce the amount of Eurozone bonds it buys, from €60 billion per month €30 billion, from January and continue the program to September 2018 or beyond.
“The lack of significant dovish surprises, however, could see EUR stabilising before long, as investors turn their attention to the improving Eurozone data,” says Marinov.
Meanwhile, the discount to fundamental value carried by the Euro-to-Dollar rate is growing wider and upside risks around the currency pair are mounting.
“Tapering should be taken as lowering fears about currency depreciation and thereby may still benefit unhedged asset allocations towards the Eurozone by foreign investors,” Marinov adds.
This continued steady risk appetite could help to keep risk-asset-related capital flows in favour of the single currency, notably, the foreign money that has flowed into the Eurozone stocks throughout 2017 to date.
“With fewer fears of currently depreciation the single currency is likely to become more positively correlated with risk sentiment. Hence, we stay in favour of buying euro on dips,” Marinov adds.
With Eurozone’s economic recovery recovery now firming, growth picking up and the ECB beginning to talk about taking stimulus off of the table, downside pressures on the Euro could continue to ease over the coming quarters.
“While such conditions increase the motivation for foreign investors to invest in EUR assets on an unhedged basis, it does also lower the single currency’s attractiveness as a funding currency,” says Marinov.
Importantly, carry traders who borrow in one currency that incurs a low interest rate and then sell it to buy something else that is offering a higher interest rate, may begin to abandon the Euro as the outlook for Eurozone rates evolves.
With a lesser number of carry traders intermittently borrowing large volumes of Euros and dumping them onto the market, downside pressures may reduce in the coming months and quarters and assets denominated in the common currency could become more attractive to foreign investors.
“From that angle we are not ignoring the possibility that the EUR will face renewed upside risks going into the year-end. As such we stick to our long EUR/USD and EUR/CHF trade recommendations,” Marinov and his team conclude.
Marinov and his team estimate that fair value for the Euro-to-Dollar rate is somewhere around the 1.26 level and forecast the pair to rise gradually during the year ahead, reaching 1.22 during the final quarter of 2017.
For 2018, Credit Agricole forecasts EUR/USD to rise steadily from 1.22 to 1.25 before year end.
Relative to the Pound, Credit Agricole forecasts EUR/GBP to trade around 0.90 throughout much of the year ahead before dropping to 0.89 around September 2018. These forecasts imply Pound-to-Euro rates of 1.1235 and 1.1100 respectively.
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