EUR/USD: Here Is Why Downside Is Now Limited To 1.10
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The EUR has been broadly range-bound for most of the last few months, mainly on the back of stable ECB monetary policy expectations. Limited room of further rising central bank easing expectations seems to have reduced the single currency’s funding status too.
In fact, the EUR has become increasingly positively correlated with risk sentiment of late. This may not come as a major surprise as, in an environment of stable rate expectations, capital flows, which remain positive, should become more important in driving the currency.
We see limited scope of the ECB considering additional policy steps anytime soon, irrespective of medium-term inflation expectations as measured by 5Y inflation swaps remaining close to historic lows. Hence, risk sentiment and capital flows may continue as an important currency driver in the road ahead.
Given limited room of global and major central banks turning more aggressive on monetary policy, it will increasingly be about global growth expectations to drive sentiment. When it comes to the Fed, further rising rate expectations will depend on constructive incoming data. Under such conditions, better growth prospects may compensate for a higher rate’s dampening impact on sentiment. At the same time better growth may come to the benefit of global conditions too. In conclusion, it cannot be excluded that sentiment remains firm for longer.
As a result of the above outlined conditions it appears unlikely that the EUR will face more considerable downside from the current levels. According to our forecasts any downside risk should be limited to 1.10. In the case of risk sentiment remaining stable, the pair may by the end of the year easily trade back close to this year’s high or above, regardless of increased Fed rate expectations.
Last but not least markets remains short the EUR, at least as indicated by our FX positioning monitor. Hence, rising expectations of the Fed to hike or even the fear that the ECB may sound more dovish is already reflected in positioning. The main risk to a constructive EUR view is related to political events such as the Italian constitutional referendum and/or German and Austria elections. However, such events are unlikely to turn into real event risk for the single currency.
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