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Jane Foley, Senior FX Strategist at Rabobank, suggests that the recent weakness of the EUR/USD pair is despite the fact that the USD’s fundamentals have arguable worsened in the past few weeks, thereby highlighting the risk factors that the market is currently attributing to the EUR.

Key Quotes

“Over the past few weeks some Fed officials have acknowledged that there are headwinds to global growth. The market has responded by reining in its expectations regarding the extent of policy tightening for the Fed.   Assuming that the Fed hikes rates next month and in Q1 2019, we expect that it will struggle to tighten policy further this cycle.   While this marks us out as being more bearish on the Fed than the market consensus, we expect the greenback to hold relatively firm.   This is because we see potential for risk appetite to remain under pressure and for the fundamentals behind the EUR also to sour.”

“This week ECB President Draghi has maintained his commitment to halt the central bank’s stimulus programme and reiterated the view that Eurozone inflation is set to increase. The market, however, is having difficulty ignoring the deterioration in recent economic releases.”

“Although Draghi’s optimism suggests that the ECB are set to push through with its plan to end its asset purchases programme, there is an understandable doubt as to how far the ECB can extend policy normalisation.”

“This morning the EUR was undermined by a report in a German magazine citing EU sources as suggesting that US President Trump could impose tariffs on imported cars from next week.   In addition to the impact from trade, Brexit has potential negative consequences for the Eurozone economy and the EUR as does the possibility of a drawn out fight between the Italy’s populist government and the European Commission on budgetary matters – though this week hopes for a compromise have been raised.”

“It has been our view for some time that EUR/USD is on course to approach the 1.12 area before the middle of next year. We maintain this forecast.   Although we see scope for EUR/USD to recover some ground in H2 2019 on the back of a deterioration of US fundamentals, given the headwinds faces by the EUR we see any bounce back to be modest.”

“On a 12 mth view we expect EUR/USD to rise to 1.14.   The outcome of the European parliamentary elections in the spring and the risk of a more dovish ECB policy could present downside risk to this view.”