EUR/USD seems to be entrenched in a lower range. What’s next?
The team at NAB lays out the battle lines ahead of the Fed and the ECB:
Here is their view, courtesy of eFXnews:
How much is December Fed rates ‘lift-off’ now in the price of the dollar? How much is intensification of ECB easing in December in the price of the euro? Heightened geopolitical tensions, China and Emerging Market currency risks aside, the Fed and ECB policy implications for the exchange rates are rightly now front and centre of the market’s collective mind.
On the dollar side of the EUR/USD equation, the minutes of the FOMC’s October meeting published last Wednesday make pretty clear that in the absence of a disastrous November US payrolls report or, we’d suggest, a major global equity market meltdown, the Fed will move its funds rate target range up by 25bps following the 17 December FOMC meeting. Though money markets still only ascribe about a 70% probability to December lift-off, it is our contention that FX markets have travelled for much of 2015 with much greater confidence than the rates market that the Fed will be delivering on its conditional promise to raise rates before 2015 is out.
Dollar strength to constrain Fed…and limit dollar strength. If the Fed is to deliver no more than two additional tightenings in 2016, we’d struggle to believe this is going to deliver a materially higher dollar. Indeed, in our latest FX forecasts, that encompass a modest downward adjustment to our EUR forecasts in the next few quarters. we only have the narrow DXY dollar index appreciating by about 1.5% in 2016. Relevant to this view is the somewhat circular argument that the strength of the dollar is in itself likely to represent a significant constraint on the extent of tightening next year.
EUR forecasts tweaked back down. It is partly for the above reasons that we are not overly bearish on the euro here, preferring to consider EUR/USD as more likely to be a 1.00 -1.10 currency rather than our previous characterisation as a 1.05 -1.15 pair. The extent of prevailing short positioning in the euro tempers any enthusiasm for suggesting a fall below parity over the forecast horizon.
We have little doubt that between now and end-2016, we will experience several ‘risk-off episodes’. In the meantime, the euro’s funding currency status is likely to be further enhanced by whatever the ECB announces on 3 December. The 6% fall in EUR/USD since 22 October has, judging from Mr Draghi’ s remarks on 12 November (when EUR/USD was already sub- 1.08) evidently done nothing to dampen his enthusiasm for undertaking further action next months. Draghi contended that “downside economic risks are clearly visible” and that “inflation dynamics have somewhat weakened”.
We look for the ECB to deliver another 10 -15bps reduction in the Deposit rate (from -20bps) as well as increasing the QE quantum from the current €60bn per month. While partially discounted, we still think this will serve to at least validate the recent move lower in the euro. Hence we now see 1.05 as a pivot for EUR/USD in coming months, versus 1.10 previously.
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