Strong growth and creditor status protects EUR - Rabobank

Jane Foley, Senior FX Strategist at Rabobank suggests that while it is difficult to justify this year’s gains in EUR/USD on the basis of interest rate differentials, the ECB has revised up its estimate for Eurozone growth to 2.2% y/y, which is the highest level since 2007. 

Key Quotes

“In addition Draghi stated that there was “strong momentum” in the economy which is leading to broad-based growth.  This environment is supportive for corporate probability and for investment particularly given the low interest rate backdrop.   These factors are positive for EUR/USD especially when measured against the more sluggish than anticipated growth rate in the US and disappointment over the lack of fiscal reform by the Trump Administration.”  

“We have argued for many months that the USD’s losses this year have been a crucial driver of the rotation into the EUR.  Without widespread investor disappointment over the lack of new fiscal incentives in the US it is unlikely that the pace of the EUR/USD uptrend would have been able to manage its 14.5% year to date appreciation.  CTFC speculators’ data indicate that as USD net positions have turned short this year for the first time since 2014, EUR net positions have surged to multi-year highs.  The pace and the extent of the build-up in EUR long positions may have implications for the outlook of the exchange rate.”

“On face value, now that the market is long, the EUR should be more vulnerable to negative news.  However, the Eurozone carries a large current account surplus.  Its status as a creditor nation should provide the EUR with a significant cushion.  Many of the inherent structural issues within the Eurozone that were highlighted by the debt crisis at the start of this decade may still be present, but strong economic growth will dull the memory and the risks connected with these events.  That said, as in the past strong growth may also counter the appetite to reform – though this is unlikely to worry EUR bulls in the near-term.”

“In theory the fact that the market is now short USDs suggests that the greenback is likely to be more reactive to good news than to bad.  In practice, investors are currently finding it difficult to see beyond the gloom. In recent months, political scandals concerning the White House and a growing sense that the Fed will be unable to hike rates again this year have encouraged the sour tone in the greenback.  This week’s news that a compromise regarding the US debt ceiling has been reached may be worthy of a sigh of relief.  However, the deal will expire in 3 months meaning that this issue will be back on the table at the end of the year.”

“Both the debt ceiling negotiations and the debate about tax reform are expected to lay wide open the deep divides between Republican Party factions.  The USD stands to gain on any sign that a compromise over tax reform can be met, particularly if it concerns the repatriation of overseas earnings by US firms.  However, currently few investors appear convinced about the likelihood of this outcome.”