Several argument for a lower EUR/USD near term…:
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Relative rates: still in favour of USD.
A Brexit will weigh on EUR/USD given prolonged political uncertainty.
The US business cycle now looks stronger than the Eurozone’s.
…but several arguments for a higher EUR/USD medium-term:
Valuation: EUR/USD remains substantially undervalued.
External balances: the EU/US CA differential is at its widest level since 2004-06
Medium term, the ECB will become more tolerant of EUR strength as CPI picks up.
FX outlook
1-3 months: we expect EUR/USD to fall on relative interest rates, Brexit risks and cyclicals
6-12 months: we expect EUR/USD to rise on valuation and external balances.
FX strategy
• USD income/assets:
− Up to 3M: Hedge USD income via risk reversal strategies that utilise the extreme option skew.
− Beyond 6M: gradually increase hedges via forwards – beware that higher US rates should make forwards less attractive over time, i.e. don’t wait too long.
• USD expenses:
− Up to 3M: we recommend hedging USD expenses via forwards.
− Beyond 6M: hedge against USD weakness through options (e.g. knock-in forwards).
Long-term investors should stay long EUR/USD.
