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EUR/USD Parity in 2017 According to MUFG but Citi target 1.08

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Forecasters who say the Euro will par the Dollar are starting to look as though they have made a decent call.

The Euro has now fallen against the US Dollar for nince consecutive trading days and trades at 1.0713 which represent 11 month lows for the pair.

EUR/USD remains under pressure and yesterday's rally did not even reach the first resistance at 1.0821 the previous March low.

Momentum is firmly behind the Dollar and the number of analysts saying the shared currency is on a collision course with parity have grown.

Traders see about a 43 percent chance the European currency will sink to $1 within a year, almost double the probability assigned a week ago, data compiled by Bloomberg show.

“Initial comments & actions from Trump (acceptance speech; some backtracking on Obamacare; soothing words on China relations and choosing a Congressional insider as Chief of Staff) point to the reflation trade fuelled by tax cuts and infrastructure spending continuing and pointing to the need for the Fed to alter communications on policy actions,” say Bank of Tokyo Mitsubishi UFJ in a recent forecast note to clients.

As a result of their hypothesis, they see the pair falling to parity sometime in 2017.

The note comes alongside a similar one from Deutsche Bank where analysts have reaffirmed their long-held belief the Euro will par the Dollar in the current cycle.

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Citi Forecasts say Parity to be Avoided but Stay Bullish on the US Dollar

Analysts at Citi are also bearish EUR/USD and foresee an orderly decline in store for the pair, ever since the presidential election.

One of the factors dictating the decline since Trump’s ascendancy is the less confident rhetoric coming out of the European Central Bank (ECB).

“ECB has softened their tone after the Trump victory. Concerns on the growth outlook for Europe as well as EU stability have limited a follow through in the “hawkish” rhetoric picked up last week,” say Citi.

Another reason for expecting more Euro weakness is the fear that Trump’s victory marks a general rise in the popularity of far-right anti-EU parties in the Eurozone.

With several general and presidential elections in key Eurozone country’s in 2017, there are concerns voters will turn against the EU and vote for nationalist parties instead, undermining the institutions of the EU, including the Euro.

“Several of Euro’s anchors have been questioned after Trump’s victory. Eurozone stability, European trade and political relations are all longer-term drivers for Europe. They will change, possibly undermining investor confidence in the macro outlook for 2017/2018,” said Citi.

One interesting point made by Citi is that, “unlike the US, political surprises in Europe are unlikely to bring “fiscal stimulus.”

This means that if a hard-right, anti-establishment party wins in Europe it will probably not increase government spending, despite repeated calls for more action from the ECB to support their monetary efforts.

As such, unlike Trump’s win which has strengthened the Dollar, the Euro would probably fall if a Trump-like politician wins in Europe, as Sterling did after Brexit.

Meanwhile, Citi are bullish on the Dollar going forward.

According to analysts, the post-election drivers of USD strength are anticipation of: 1) fiscal stimulus 2) corporate tax reform 3) a faster pace of Fed hikes.

As long as these are the drivers there is no reason for USD strength to diminish.

"Investors are so far taking a very benign view of the incoming Administration’s likely impact on asset markets, taking their cue from President-elect Trump’s early comments on infrastructure spending and tax reform, including earnings repatriation. Trump, Republicans and even some Congressional Democrats support corporate tax reform, so this looks like low hanging stimulus fruit in the early part of the new Administration link," say Citi.

This is pushing up US equities, nominal yields, real yields and inflation expectations, a pretty good deal if you own US assets and USD.

The expected slope of the fed funds rate path is the highest since March, suggesting that investors are also seeing the Fed as more aggressive, but not aggressive enough to derail asset market gains.

CitiFX added to its technical portfolio last week a short EUR/USD from 1.09  and a long USD/JPY from 106.75.

Orderly Depreciation

Citi may be bearish for the Euro but they don’t see a sharp slide, rather an “orderly” decline’.

This they base on the fact that key medium-term drivers for the Euro are likely to be outperformed by the same drivers for the Dollar.

These key medium-term drivers are based on the balance between money exiting and entering the Eurozone, in the form of Foreign Direct Investment, Portfolio Flows, and Current Account Flows.

Whilst these have generally favoured the Euro previously, the rise in US yields and a positive outlook for US assets, in general, suggests the US will see a rise in flows, which outpaces that seen in the Eurozone.

The growing difference between flows for the two currencies is likely to favour the dollar in the medium-term.

One interesting offsetting influence which would slow declines for the Euro is likely to come in the form of a fall in Eurozone portfolio outflows during 2017 as the ECB starts to taper its monthly bond purchases.

Demand from the ECB often uses up all available supply of bonds thus forcing fund managers to look outside of the Eurozone, and therefore leading Euro-weakening outflows.

The impact of these factors will be slow and measured, however - explaining the ‘orderly move lower’ in EUR/USD envisioned by Citi.

On a 0-3 month timeframe Citi see the EUR/USD at 1.08 ahead of a rise to 1.15 in a 6-12 month frame.

US Dollar Rally Could Take a Breather, Yellen is Key Risk to Outlook

The US Dollar has been the standout performer this week with the US Dollar index climbed to its strongest level in 14 years on Wednesday November 16 as the momentum provided by the recent Trump victory continued to be felt.

But there is a sense strength could start to fade.

"There's no doubt that recent moves have been exaggerated," says Kathy Lien at BK Asset Management in New York. Lien believes weaker U.S. data - producer prices and industrial production - are part of the reason that the rally has peaked.

All eyes will be on Federal Resreve Chair Janet Yellen today, with her testimony to the Joint Economic Committee gaining even more attention following Donald Trump's election coup.

The possibility of a major shake-up at the Fed means that we're likely to see the Congressional committee focus on big-picture themes; in addition to discussions over a possible “Audit the Fed” bill and Taylor-rule style policy approach (both of which were scrutinised last year).

However, from a Dollar perspective today will be our first chance to gauge whether there is any real substance behind Yellen's inflation-overshooting theory.

"The Fed Chair recently floated the idea of running the economy hot to overcome any hysteresis associated with the financial crisis," says Viraj Patel at ING in London. "Hence, in a world where the Trump administration is looking to deliver a sizeable fiscal package, the optimal policy stance here would be to keep rates lower than otherwise would have been the case under a strict 2% inflation target."

ING believe this has a significant bearing on how markets may unfold in 2017: a bearish steepening of the US yield curve is likely to be less damaging to the global risk environment than a bearish flattening, and the Fed normalising rates quickly to anchor inflation.

"With a 94% probability of a Fed rate hike now priced in for Dec, and almost 1.5 hikes expected in 2017, we think any Fed-fuelled $ upside will only occur if Yellen explicitly rules out scope for running the US economy hot. Risks are that the USD rally takes a breather," says Patel.