EURUSD: Only limited downside potential - Rabobank

Jane Foley, Senior FX Strategist at Rabobank, attributes most of the recent move lower in EUR/USD to broad-based USD strength, the fact that EUR has underperformed the yen and the majority of other G10 currencies this month adds credence to the view that it is exhibiting some independent weakness.

Key Quotes

“ECB President Draghi injected some volatility into the value of the EUR with his hints about the future of the Bank’s asset purchase programme. Once again Draghi confirmed that the Governor Council did not discuss extending the intended horizon of its purchase programme and once again this took the market by surprise initially sending the EUR higher. The gains, however, were short lived as Draghi confirmed that it would be very unlikely that bond purchases would be ended abruptly. The implication is that there would likely be an extension to the ECB’s asset purchases plan that would take it beyond its current March end date.

Technically the threat of further central bank easing is a currency negative factor. However, with the exception of last week’s EUR move, hints about looser monetary policy from central banks such as the ECB, BoJ, RBA and NZD have had little impact on weakening their respective currencies this year. We have frequently argued that this is due to the overwhelming impact of the US yield curve. Counter to the trend exhibited this month, for large parts of the past year and a half the market has been pushing back expectations regarding the pace and extent of policy tightening from the Fed. Lower US yields have resulted in a soggy USD which have proved difficult for other central banks to push back against. By contrast the recent push higher in US treasury yields and the USD has handed back to dovish central banks such as the ECB more scope to undermine the value of its currency.

Another factor that has influence on how far a currency pair can be moved by a perceived change in fundamentals is positioning. CFTC data suggest that speculators are holding net short EUR positions. The level of net shorts positions has jumped higher since the end of last month consistent with the fall in the spot value of EUR/USD. However, these data also show that the current level of net EUR shorts is still less than half of the positions maintained in early 2015. This suggests there may be further appetite to shorten EUR positions beyond current levels.

Simultaneously USD long positions have been eroded to just a fraction of the levels held in the middle of last year. USD longs rocketed higher last week and, on any clear re-evaluation of inflation expectations, the USD could have a lot further to go. That said, given our scepticism about the build-up in US inflation, we see only limited downside potential in EUR/USD and continue to forecast trading range centred around the 1.09/1.10 area in the coming months.”