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The Euro-to-Dollar rate has dimmed this week after the European Central Bank quashed market hopes of an initial Eurozone interest rate rise in June 2019, leading a long line of currency strategists to downgrade their forecasts for the single currency.
There is still a wide variation between forecasts of those who are bullish and bearish in their outlook for the currency although, tellingly, some of the most optimistic forecasters in the market have slashed their estimates for the Euro-to-Dollar rate dramatically and no longer expect it to see new highs this side of the New Year.
"While the ECB’s dovish guidance itself isn’t a reason to chase EUR/USD lower, we envisage an even shallower EUR/USD move up towards 1.23 by year-end. But for now, expect to trade within a narrow 1.15-1.18 range – as we remain stuck in a ‘Trade War trap’ (which tilts the risks towards a EUR/USD correction higher)," says Viraj Patel, an FX strategist at ING Group, in a note to clients Thursday.
The ING FX team had until recently forecast that the Euro-to-Dollar rate would reach 1.30 before the end of 2018, making them one of the most bullish set of forecasters in the market, although they now predict the exchange rate will sit at 1.23 around the turn of the year. EUR/USD was quoted above 1.23 as recently as the middle of April, although it was trading at 1.1594 Friday.
The European Central Bank said Thursday it will continue buying €30 billion of European government bonds each month until the end of September 2018, at which point the rate of monthly purchases will be cut to €15 billion before being reduced to zero at the end of December. This should have been a positive development for the Euro.
However, the central bank also quashed earlier hopes among traders that it would be in a position to raise interest rates from their record lows in June 2019, dealing a crushing blow to the single currency and a broad swathe of forecasters who had hoped that an end to the era of ultra-low interest rates was near.
"The Governing Council expects the key ECB interest rates to remain at their present levels at least through the summer of 2019 and in any case for as long as necessary to ensure that the evolution of inflation remains aligned with the current expectations of a sustained adjustment path," says the ECB, in its statement.
Markets had come to believe that an interest rate rise would not only be possible, but likely, in the Eurozone as soon as June 2019. This was why currency traders had got so excited about an end to the ECB's quantitative easing programme and had previously bid the single currency 17% high against the Dollar during the year to April 2018.
"We remain bearish EURUSD and would sell any rallies. Looking ahead, we expect relative data, trade policy and developments in Italy to be the main EURUSD drivers. The ECB has effectively took itself out until at least September 2019-with the exception of the discussion about Draghi's replacement, which is likely to intensify by the end of this year," says Athanasios Vamvakidis, European head of FX strategy at Bank of America Merrill Lych.
Vamvakidis and the Bank of America team forecast the Euro-to-Dollar rate will finish 2018 around the 1.20 level, which is where a majority of forecasts now appear to be settling, but warn of further losses for the single currency in the short term. They have been betting against the EUR/USD pair during recent months, advocating in mid-April that clients bet on a fall in the exchange rate from 1.2378 to 1.15 before the end of June. That trade now looks close to being complete.
"The end-2018 forecast is cut from 1.25 to 1.20 while the mid-year forecast is set at spot to convey the lack of clarity around the next move in Italy," says Paul Meggyesi, vice president of global currencies and commodities at J.P. Morgan, in a briefing days ahead of the ECB announcement. "The situation in Italy remains fluid and the focus is now on the details of the new government’s programme, specifically the extent of fiscal easing, and whether the parties choose to clarify their ambivalent attitude towards the single currency."
As much as many strategists are citing the European Central Bank statement on interest rates as the driver behind their forecast upgrades, the ascent to power of a Eurosceptic government in Italy and slowing economic momentum were already pushing once-bullish strategists into or toward downgrades. The faint hope of a positive shift on the Eurozone monetary policy front was the only factor preventing the last holdouts from biting the bullet.
The FX team at J.P. Morgan, who've been a bullish bunch when it comes to the common currency during recent quarters, took the plunge and cut their forecasts before the ECB dented the currency on Thursday. However, even they are still warning of the potential for further losses in the short term, mostly due to stale "positioning".
"Technically, however, EUR remains vulnerable from a further unwind of speculative longs positons and/or a further correction in the overvaluation of EUR vs short-term, interest rate based models," Meggyesi wrote last week.
Speculative bets in favour of a rise in Euro exchange rates reached their highest level for more than three years during the first quarter of 2018 and, although the amount of money riding on a further increase in the single currency has fallen by 40% since then, Meggyesi and the J.P. Morgan team say there is still $13 billion of speculative money chasing this trade.
Closure of these positions, which would require the traders in question to sell the Euro back to the market, could push the Euro-to-Dollar rate all the way down to 1.13 for a short period according to Meggyesi. But not all are convinced that it's time to capitulate on their earlier forecasts for the currency.
"After the ECB meeting and strong US economic data, the Euro depreciated strongly against the US-Dollar. However, we believe this US-Dollar strength is only a temporary phenomenon, and we maintain our forecasts of a EUR/USD at 1.25 by year-end," says Dr. Karsten Junius CFA, chief economist at Swiss asset manager J Safra Sarasin.
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