- EUR/USD to fall as interest rate differential weighs says Rabobank
- But J.P. Morgan says shallow uptrend to remain intact in 2018.
- Maybank calls for EUR/USD gains as ECB ends QE in second half.
© Grecaud Paul, Adobe Stock
Currency analysts covering the Euro-to-Dollar rate are still heavily in favour of another move North this year although cracks are beginning to appear in this consensus, with some eyeing the potential for a short term correction lower while others are increasingly suggesting the single currency may already have seen its best days for 2018.
Discussions about the future trajectory of the EUR/USD pair come at a time when the exchange rate appears to have stalled. It has traded in a sideways range between 1.2150 and 1.2550 ever since setting a new three year high back at the end of January although, quoted at 1.2375 Wednesday, it has struggled to break back into the top half of this range during recent weeks.
"The latest Reuters FX survey points to a rise in EUR/USD to 1.28 on a 12 mth view, similar to the predictions made in the March poll. In contrast to the consensus expectation, we revised lower our forecast for EUR/USD last month from 1.28 to 1.21," says Jane Foley, a senior FX strategist at Rabobank. "The reasons for this stemmed mainly from positioning and interest rate differentials with technical analysis also playing a part."
Positioning, which refers to the amount of speculative money stacked in favour of or against a particular currency, has been an impediment to further Euro gains throughout much of the first quarter. According to Chicago Futures Trading Commission data, the largest currency positions held by institutional investors during the week to April 03 were bullish bets on the Euro, although similar has been true of each and every week in 2018 so far.
Building these large bets may have helped buoy the Euro higher in months gone past but this positioning is now a problem for the currency, particularly in the context of its stalled advance, because the longer the exchange rate moves in a sideways range the greater chance there is that these investors decide to walk away from their bets.
This would see Euros dumped on the market in large quantities, although even just the threat of a "positioning unwind" alone may be enough to keep the Euro sidelined for the foreseeable future.
"More recently softer than expected German economic data and continued benign Eurozone CPI inflation data have strengthened our view that upside potential for EUR/USD could be difficult," says Foley.
Downgrading Year-End Euro Forecast
Foley and the Rabobank team have been among the bolder voices in the analyst community, breaking with the bullish consensus by downgrading their year-end forecast for EUR/USD, while others are not quite ready to give up the ghost yet despite a series of adverse events playing out over the course of March.
Eurozone inflation numbers for last month disappointed the market, which is a red flag for those hoping the European Central Bank will soon shutter its quantitative easing (bond buying) programme, while other indicators have recently shown Eurozone economic momentum beginning to wane.
This matters for the Euro because the ECB can only cease its intervention in the bond market when inflation makes a sustainable return toward the 2% target. An end to quantitative easing is necessary in order for Eurozone bond yields and, eventually, interest rates to rise.
Higher rates themselves are necessary to keep the Euro supported in a world where other central banks are increasingly looking to raise rates, which may put the single currency at a disadvantage in the scrap for international capital and speculative money flows without an offsetting action from the ECB.
"Due largely to the distorting impact of politics, interest rate differentials provided little draw for EUR/USD last year. On a long-term perspective, however, rate spreads do tend to provide broad direction for currency pairs. Therefore we do favour moderate downside potential for EUR/USD on a 12 mth view," Foley adds, referring to the widening gulf between Eurozone and US bond yields.
Rabobank have revised lower their 12-month forecast for EUR/USD from 1.28 to 1.21.
The Optimist's Take
Although Foley and the Rabobank team look for the Euro-to-Dollar rate to ease lower throughout the rest of the year, others remain hopeful of an improved performance.
"We see no convincing reason to abandon the forecast of a shallow EUR uptrend, nor sufficient reason to flip tactically short EUR/USD, certainly not when the euro continues to be supported by a powerful underlying balance of payments dynamic (a basic balance surplus of 6% of GDP versus a deficit of 0.7% in Japan, 3% in the US and 7% in the UK)," says Paul Meggyesi, vice president of global currencies and commodities at J.P. Morgan.
Meggyesi and the J.P. Morgan team have flagged the potential for a US Dollar rebound against its major counterparts over the coming months due to the same interest rate and bond yield differentials cited by Foley although they forecast that this will eventually peter out and leave the Euro's uptrend intact.
Other strategists see scope for technical factors to drive the Euro higher in the short term and for optimism over an end to the ECB's quantitative easing program to grow further as the months pass, which might provide additional support to the single currency.
"Mild bearish momentum is waning while stochastics show signs of turning higher from oversold conditions. Key resistance at 1.2340 - 60 levels. An extension towards 1.2450 levels should not be ruled out if the pair manages a decisive move above 1.2360," says Saktiandi Supaat, an FX strategist at Maybank in Singapore. "With trade war tensions lingering in the background since March, markets appear to have forgotten that ECB policy normalisation is underway... a re-focus back on ECB normalisation could see EUR gains pick up pace again."
Supaat and the Maybank team have cautioned against what they describe as "excessive optimism" but are forecasting the Euro-to-Dollar rate will rise toward 1.25 and, eventually, to 1.30 some time in the second half of the year.
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