EUR/USD Valuation: From a “limiting” to an “amplifying” factor - ING

Petr Krpata, Chief EMEA FX and IR Strategist at ING, explains that not only is EUR/USD cheap, but USD is generally very expensive in trade weighted terms and while the latter makes it difficult for USD to embark on a broad-based appreciation trend, the former should facilitate the ECB-induced EUR/USD upside. 

Key Quotes

“Indeed, valuation has been a key EUR/USD factor over the past quarters. While profound EUR/USD cheapness has put a soft floor under EUR/USD around 1.05 since 1Q15 (in spite of ongoing EZ political woes and USD strength), now it should change from a “limiting” factor (which is limiting EUR/USD downside) into an “amplifying” factor that should re-enforce the EUR rebound, particularly when the EUR/USD recovery seems a long overdue. We say this based on our Error Correction Model within our BEER valuation framework, showing it takes on average 5-7 quarters for EUR/USD misvaluation to correct versus the lengthy 9-quarters of large EUR/USD undervaluation (since 1Q15) currently in play.”

“EUR/USD is currently undervalued by around 12% on a medium-term basis (a large undervaluation in both absolute and relative terms), providing a plenty of scope for EUR/USD to move above (and overshoot) the 1.20 level in coming quarters/years. For reference, OECD PPP fair value estimate (PPP is a long-term estimate, longer than our medium term BEER) is even higher, currently at 1.34.”