EUR/USD: Higher Still on Valuation as ECB Gives Up its Euro Fight – Danske Bank
Christin Tuxen, Senior Analyst at Danske Bank, suggests that the US data have started to surprise on the upside while that out of Europe continues to disappoint.
“Notably in the US the manufacturing sector is starting to rebound after months’ of distress driven by the strong USD and/or depressed energy sector.
Monetary policy. The ECB delivered on easing but notably shifted its focus from the exchange/interest rates channel to the bank-lending/credit channel. The latter is not the quick fix for the euro-zone inflation outlook that a further depreciation in the euro may have been, and is a clear signal that the ECB will no longer fight euro strength by all means. Indeed, Draghi and co have clearly stated that the central banks prefer QE rather than further rate cuts as the main easing tool from here.
Following the dovish Fed message in March we continue to expect that the Fed will hike only once this year. While this is close to market pricing for 2016, we still believe there could be some upside to short-end US rates down the road as pricing for 2017 is very subdued.
Flows. Speculators have become notably less stretched short EUR/USD; this likely increases the sensitivity of the cross to any impetus from relative rates.
Valuation. Both our PPP and MEVA model suggest 1.26 is ‘fundamentally’ justified; thus, the cross is undervalued on both metrics.
Risks. The risk of a Brexit is a EUR-negative factor which has yet to be factored more firmly into EUR crosses but could gain traction as the UK June referendum is approaching.
With the Fed set to deliver merely a September hike this year, in our view, the case for USD upside from Fed repricing near term looks increasingly weak. At the same time, the ECB has now given up the fight for further euro depreciation. In the absence of USD support from relative interest rates near term, we are likely in for range-trading in the 1.10-1.14 interval for the pair near term before a more sustained move higher further out.
We now look for 1.12 both at a 1M and 3M horizon (prev. 1.10 and 1.08, respectively). Beyond 3M, we continue to stress that fundamental factors – not least valuation – will drive EUR/USD higher – notwithstanding some upward pressure on USD rates. We are rolling in our 6-12M forecasts now looking for 1.14 in 6M (prev. 1.10) and 1.18 in 12M (prev. 1.16). Thus, we no longer expect a sustained dip in the cross to precede a move higher longer term.”
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