EUR/USD Unlikely To Hit A New Cycle Low: Where To Target?
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The post-referendum fall in sterling has been precipitous, but orderly. The UK 10Y real yield currently matches the record lows reached in the spring of 2013. Interestingly, the nominal trade-weighted sterling is currently at levels prevailing in March 2013 too, with cable being much lower but EUR/GBP still slightly short of the 2013 highs (~0.88). Sterling's fall has followed the drop in the UK's real yields. This is not to dismiss the dangers inherent in the UK running a huge current account deficit, but there is no sign of panic currently in the pound's depreciation.
One major flipside of the precipitous sterling weakness is euro strength, compounded by the persistent though more gradual decline in the renminbi. The ECB's nominal trade-weighted euro exchange rate has risen by 4% over the past year and 2.4% calendar year-to-date. It has admittedly not appreciated much since April 2017, but is trading at the higher end of the oneyear range.
Continued depreciation of sterling and renminbi against the euro into year-end looks likely, however, while offsetting yen strength is now coming up against mounting risks of market intervention with USD/JPY at 100/101. This obviously confounds the ECB’s attempts to ease monetary conditions further in the Euro area (EA), where deflationary pressures remain. Moreover, there will be a negative growth impact from Brexit, which could cost the region 0.1pp of GDP per annum by 2020 (or 0.7pp of GDP on a cumulative basis) according to our European economists.
In this regard, the global macro environment has become more difficult for the ECB in the aftermath of the UK referendum. Half the EA's sovereign bonds are yielding less than zero. The German 10-year Bund yield fell to a record low of -0.205% recently for example. European yields are basically a lot closer to the lower nominal bound now than US or UK bond yields. One consequence is that the euro is becoming resistant to monetary-induced weakness. The ECB’s trade-weighted euro has been about flat since 23 June, despite the hit to the region’s growth outlook from Brexit.
The relative strength of the euro is a symptom of the ECB approaching the effective limits of its policies. This is a key factor in our expectation that EUR/USD is unlikely to hit a new cycle low over the next year, and our view that EUR/USD is trading off Fed expectations more than ECB policies.
SocGen targets EUR/USD at 1.10 by the end of Q3, at 1.08 at the of Q4, and at 1.05 by the end Q1' of next year.
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