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With EUR/USD having nearly just reached the 1.20 target earlier this week, economists at Deutsche Bank now favor taking profit and see a more balanced outlook as September approaches. It is still possible EUR/USD goes for a small break above 1.20 for the rest of the year but they think consolidation around 1.20 is the most likely outcome. 

Key quotes

“The euro range of 13 big figures so far has now reached what would be a ‘normal’ range for the year. A peak around 1.20 would be entirely ‘normal’. A move towards 1.23 would make the range extreme and suggest ultimate exhaustion. Similarly, we had identified 1.20 as a level where leveraged positioning on the CFTC would turn to a small long. This is indeed what has happened, so there is scope for a further extension in positioning up to the 2018 highs which would be equivalent to around 1.22. But more worryingly the broader CFTC metric of euro positioning has now reached record highs. Positioning is a bigger concern now.”

“Relative data surprises between the US and the rest of the world have turned back to flat from being extremely favourable to the US at the start of the year. US data can of course deteriorate further as the fiscal cliff unfolds, but on the other hand virus divergence is over with European COVID cases starting to accelerate again which could dampen European momentum as we head into Q4.”

“American yield exceptionalism can decline further, most notably via real yields if the Fed stays true to its word of the need for very accommodative policy. But in recent months the Fed has signaled aversion towards yield curve control and negative rates. More importantly, the FOMC minutes yesterday left an open question mark on whether the Fed would do more aggressive QE by the September meeting.”

“On the ECB side, we have now reached levels in the euro trade-weighted that have historically led to heightened risks of ECB verbal intervention. Meanwhile, the level of BTP-bund spreads has reached pre-COVID levels suggesting that the ECB backstop on Italy is fully priced in. In all, taking the sum of US real yields and BTP-bund spreads as a proxy of the key driver of higher EUR/USD this year it has reached all-time extremes.”

“There is of course scope for a EUR/USD extension above 1.20. US policy dysfunction has scope to turn uglier as the polarized phase of the US election materializes. The three-month run-up to the US election is the period where the market starts to pay more attention to the event. A further extension of these drivers would conveniently coincide with a build-up in more extreme positioning and ranges. But we would view any move above 1.20 as consistent with an over-shoot rather than a move to chase. Bottom line, EUR/USD around 1.20 is close to fair value as things stand.”