After a rough week, where the main event was Draghi’s dovish speech, the single currency has been trading on a firmer footing and erased partially losses. Since last Friday, EUR/USD rose more than 0.85%, from 1.1177 to 1.1276, as investors slowly digest the new outlook for interest rates. Indeed, a couple of days after the announcement that the ECB would put on pause its tightening process, market participants realized that the Federal Reserve was also on pause. Therefore, if interest rate differential is already priced in and is not expected to change any time soon, what investors should focus on? Let’s have a look at growth prospect for both countries.
The FOMC has revised its growth outlook substantially to the downside. At its December meeting, the Fed lowered its growth forecast for 2019 from 2.5%y/y to 2.3% - not a major change, I agree. However, yesterday Atlanta Fed issued fresh growth forecast, which are based on domestic retail sales data, for the first quarter. Economic growth is expected to ease to a 0.2% annualized rate. Looking at the Atlanta GDPNow previous estimations using different output, GDP growth for the first quarter is estimated to be somewhere between 0.2% and 0.5%, which is still much lower than what the Fed calculated in December.
Across the Atlantic, The European Central Bank trimmed its growth forecast for 2019 to 1.5% from 1.8% - a 0.3% downside adjustment. Based on both central banks’ estimates. It seems that the euro area would bear the brunt of the slowdown, which should be ultimately be dollar positive. However, we believe that US growth is widely overestimated, mostly because the positive effect of the tax cut implemented by the Trump administration will fade away, while the cost of debt servicing will channel revenue away from investment and thus growth generation. Indeed, higher interest rates means higher interest payments. Against such a backdrop, we anticipate that the single currency will continue to appreciate against the buck - even though it would be a bumpy road – and will reach 1.15 by the summer and 1.24 at the end of the year.