Euro Exchange Rate’s Surge is an Over-Reaction, Must Come Down: ING

At Pound Sterling Live we are not convinced the moves higher on Thursday are Fed-inspired, rather the euro may be benefiting from flows related to a DAX-inspired market sell-off.

ING have labelled the sudden rally in the euro exchange rate complex over the past 24 hours as an overreaction to the US Federal Reserve’s tepid stance on raising interest rates in 2016.

The euro has rocketed higher against the US dollar taking the EUR to USD exchange rate above 1.13; we are on target to test the October 2015 highs at present.

The euro to pound sterling exchange rate has meanwhile moved to just below 0.79 and is on the cusp of taking out the best levels of 2016.

Euro Overvalued

As the euro shoots higher, ING’s Petr Krpata warns the euro / dollar exchange rate is now overpriced.

“Eventually, we are likely to see a modest retracement towards the 1.10/1.11 level when the initial overreaction fades, we currently identify EUR/USD as being 1% overvalued, and risk remains bid, but a decline below this level needs an active catalyst from the USD side,” says Krpata.

ING aren’t necessarily advocating for a slump in the euro, rather a business-as-usual swing within recent, and familiar, ranges:

“The limited potential for EZ rates moving lower, following the ECB President Draghi’s indication last week that the ECB does not expect further rate cuts at this juncture, and market’s dovish take on the yesterday’s FOMC meeting,  whereby it may take time for US rates to move higher meaningfully, suggests a largely directionless and range trading environment for EUR/USD in coming weeks.”

Is this a Flow or Fed-Inspired Rally?

The FOMC’s decision in favour of a dovish pause continues to resonate across global markets.

Risk appetite has generally benefitted from the downward revisions to the ‘dots’, which now imply two hikes this year down from four previously,

However, enthusiasm on markets has since cooled thanks to negative developments on the German stock market.

“Following a strong start to the morning things turned ugly with a sharp and sudden decline from the DAX dragging down its European peers,” says Connor Campbell at Spreadex, “the DAX was hammered by multiple directions this Thursday, causing the index to fall by nearly 200 points.”

Campbell attributes to the turn in fortunes in the German market to a host of drivers:

• Commerzbank and Deutsche Bank notably weaker following the latter’s CEO John Cryan warning yesterday that the bank wouldn’t be profitable in 2016
• Deutsche Lufthansa lower on a cut to profit forecasts due to increased cut-price competition
• VW and Daimler lower as the auto-sector remains precarious following last year’s emissions scandal
• The general impact of a stronger post-Fed euro

Why Would the Euro be Higher When Markets are Lower?

The impact of weaker markets has spread to other markets, the FTSE 100 included.

The euro benefits, as we have argued many times before, in times of market stress; it is likely to suffer when stock markets are rising and benefit when they are falling.

There are signs that incredibly large sums of money are starting to flow to riskier, emerging market, assets once more.

You can bet a significant chunk of these funds are in cheap-to-borrow euros.

This dynamic is testament to the latest cut in Eurozone interest rates - it is now cheaper than ever to borrow euros to fund stock market bets across the globe.

When these bets are unwound, and currency is repatriated, demand for euros rise.

Inflation Also Boosts Shared Currency

There was further reason to buy euros on Thursday.

Eurozone inflation took an unexpected turn for the better, with the final February readings rising against expectations.

With the core annual CPI reading rising to 0.8% and month-on-month figure rising to 0.2%, there is reason to be cheerful for Mario Draghi, who will hope it is indicative of a future resurgence in price growth.

Euro strength could extend further yet. 

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