Will the Euro Keep on Climbing? - Commerzbank

Will the Euro Keep on Climbing? - Commerzbank

10 April 2016, 15:50
Roberto Jacobs

Will the Euro Keep on Climbing? - Commerzbank

Despite more expansionary ECB policies, the euro has appreciated considerably. As far as moves against the US dollar are concerned, this is partly due to markets having lost faith in a tightening of US monetary policy. What is more, the ECB has ceased to talk the euro down. Nonetheless, we continue to reckon with a weaker euro in the medium-term.

Key Quotes

"Since December, EUR-USD has strengthened significantly from levels of around 1.06 to rates around 1.14. Besides a hesitant Fed, the signals recently sent out by ECB president Mario Draghi have also played a role. How long this euro strength will continue depends largely on the US central bank. Were it to soon follow up its December interest rate move with further steps, the exchange rate would likely fall again. Moreover, the ECB will probably also react to a euro that it believes to be too strong, and other EUR-positive factors at present such as low inflation expectations should also lose potency."

"For a long time, many observers bet on pronounced EUR-USD weakness amid the “divergence of monetary policies”. Rising interest rates in the US and an increasingly expansionary monetary policy in Europe were conditions which many people thought was an ideal situation to produce a downward trend in EUR-USD. But the sums didn’t quite add up as this divergence has been smaller than expected so far."

"This is largely because the Fed clearly wants to raise US interest rates at a much less aggressive pace than assumed only a short while ago. FOMC members themselves now only expect a funds rate of 0.875% (median expectation) at the end of the year, i.e. two rate hikes this year. At the December meeting, the FOMC was still pencilling in four hikes. The expectations for the end of 2017 have also been reduced accordingly.
This signal has been strengthened by the fact that this downward revision was once more correctly anticipated by the market because of the experience of past years in which the FOMC has systematically revised the “dots” to the downside. The market is therefore pricing in an interest rate path that is well below the FOMC’s dots and with every downward revision by the FOMC, investors are less convinced that Fed monetary policy in the next year or two will deserve to be called a “rate hike cycle”. This is naturally weighing on the US currency. While it has gained an average of 7% versus other G10 currencies in the 12 months before the first Fed interest rate rise, it has since fallen by 5%."

"Although we do not expect as many Fed rate rises as the FOMC, we do anticipate more hikes than the market. Once the market corrects upwards its Fed interest expectations, this should give substantial tailwind to the US currency and weigh on EUR-USD."

(Market News Provided by FXstreet)

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