EUR/USD: Time for a breather? - Rabobank

Jane Foley, Senior FX Strategist at Rabobank, suggests that they are revising up their 12 month forecast to 1.20.  Our USD forecasts have also been shifted lower across the board. 

Key Quotes

“The victory of the Macron in the French Presidential election has ushered in hopes of reform in France and optimism regarding a period of closer Eurozone integration.  If Macron fails in either of these agenda, the EUR will no doubt pay a heavy price. For now, however, there appears to be a window of relative calm in the Eurozone political landscape coupled with a spate of glad tidings on the economic front that is showing little sign of a letting up.  Q2 data has shown that growth in Spain has returned to pre-crisis levels at 0.9% q/q, the Irish central bank has sharply revised up its forecast for domestic growth in 2017 from 3.5% to 4.5% and Greece has managed a return to the bond market – though the country clearly still has a difficult path to negotiate.”

“Currently, benign US inflation indicators are subduing US treasury yields which in turn is acting as a downward force on the USD.  That said, inflation is also relatively soft in the Eurozone.  Crucially, however, relative to the expectations that existed at the end of last year growth in the Eurozone economy has surprised on the upside this year.  This factor combined with the Macron victory in the French Presidential election has triggered a rotation back into euro denominated assets which has in turn emphasized and exaggerated the movement out of the USD.  At the same time, the increase in world growth has boosted confidence in risky assets.  Not only is the USD the worst performing currency in the G10 in the year to date, but the greenback has performed poorly measured against Asian, CEE and most emerging market currencies.”

“The improved economic backdrop in the Eurozone has fed speculation that the ECB could be posed to change policy direction.  For the most part, ECB President Draghi has been careful to push the message that the central bank wishes to be “patient” with respect to any tapering of its bond buying programme.  Although the July estimate of Eurozone core CPI inflation at 1.2% y/y was a little firmer than expected, it remains well below the ECB’s target.  Also, this year’s stronger EUR has tightened monetary conditions considerably.  Although the EUR remains undervalued vs. the USD on many measures on Purchasing Power Parity (the OECD estimate is EUR/USD1.24), central banks rarely welcome volatility in the FX market and the ECB will be keen for the rapid movement in EUR/USD to abate.”

“In view of the pace of the recent gains in EUR/USD in recent weeks, there is risk that a pullback or at least a period of consolidation will be forthcoming.  That said, based on our expectation that the Fed will not act again on policy this year and given market expectations that the ECB is gearing up for a message on tapering in the autumn, we see EUR/USD edging up to 1.19 by year end and 1.20 on a 12 month view.”