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Based on fluctuating hopes that another election may yet be avoided in Italy, a better open for Italian bonds this morning has produced some support for the EUR, according to Jane Foley, Senior FX Strategist at Rabobank.

Key Quotes

“Although the pace of the drop in EUR/USD in recent weeks has outpaced our forecasts, we continue to see downside potential and have revised down our 12 mth EUR/USD to 1.12 from 1.15.   Given the risk that the market will take a breather after the recent plunge in EUR/USD, we are targeting 1.15 on a 3 month view.”

“Recent develops give us reason to extend our bearish EUR/USD view.”

“Over the past few weeks, investors’ fears have grown.   Initially these were about fiscal compliance with Brussel’s rules and more lately these have been laced with fears that about Italy’s future in the EU.   Since even the League’s leader Salvini has denied that he wants Italy to leave the system, this scenario currently appears unlikely.   That said, it is now a topic that will colour election campaigns if an early return to the polls is called.”

“With market attention firmly back on political risk in Italy and also Spain, given the forthcoming vote of no confidence in PM Rajoy, the outlook for the EUR has clearly soured. Added to this is our existing arguments regarding the more constructive outlook for the USD.”

“The Fed has remained consistently hawkish this year, maintaining that three rate hikes in total are likely in 2018. There has been plentiful talk that the Fed could raise rates four times this year.   In contrast to this hawkish position, most other G10 central banks have pushed back against market expectations for tighter monetary conditions.   Along with the ECB, the BoJ, Riksbank, RBA, RBNZ and BoE have all made some effort this year to downplay expectations of tighter monetary conditions.   The result is that interest rate differentials are favouring the USD.”

“Last year interest rate spreads failed to lift the greenback.   2017’s goldilocks scenario for EM assets, saw investors rushing into high yield assets. By contrast the drop in risk appetite this year and the outflow from many Asian and Latam EM markets has also favoured the USD.   Broad speaking we maintain a positive view on the greenback.”