US investment bank Morgan Stanley have taken an island stance remote from other major banks in calling parity for the EUR/USD by the end of 2016.
Their forecast stands apart even from that of one-time perma-bears Goldman Sachs, who previously had called for EUR/USD to fall to a sub-parity 0.95. However, after an embarrassing backstroke to parity in late 2015, they eventually even had to accept that was too low, raising their forecast in December to 1.05, after admiting to have “badly misread” the ECB ahead of its rate meeting.
Concerns about the rising balance sheet exposure of Euro-zone financial institutions, who have greater ratio of non-performing loans compared to non-European brethren is a major factor in Morgan Stanley’s fresh downward revision. Add to this the impact on tight bank margins caused by the ECB’s negative rates policy, as well as a general lack of credit transmission to the wider economy and you have the perfect storm brewing for the euro:
“Outside JPY, CHF, USD and SEK, it is hard to find a positive currency story. In fact, the outlook has weakened further in some cases, such as GBP and EUR.”
Global Money Tight
Morgan Stanley's analysis assumes a backdrop of constrained global liquidity conditions, caused by repatriation of yen by Japan and a rising dollar, which are likely to make, “creditors more selective about where to place their funds.”
In such an environment Euro-area banks will come up for closer inspection and may be found wanting:
“We think that FX investors will start to become more concerned about the large balance sheets in the European banking sector.”
Banks Face Multiple Headwinds
Whereas during the peripheral debt crisis of 2011 the weight of non-performing loans on the books of euro-zone peripheral banks were the central concern, this time it is not so much a question of bad loans alone but rather a poisoned cocktail of narrowing credit spreads due to ECB’s negative rates, a lack of willingness to lend to the wider economy and the legacy of bad loans altogether:
“This time it is not so much the asset outlook that concerns EUR traders. Instead, it is the capacity to fund large balance sheets, the impact on bank credit spreads, and the ability and willingness of banks to provide credit that may send EUR lower, in our view.” Says the Morgan Stanley note.
This has informed their most recent forecast for EUR/USD to fall to 1.06, 1.03 and 1.00 at the end of Q’s two, three and four respectively.
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