EUR/USD to consolidate at higher levels in the month ahead – MUFG

The euro has made a weak start to the New Year. In contrast, the US dollar has been one of the better performing currencies alongside the Norwegian krone and Australian dollar. Nonetheless, economists at MUFG Bank expect the EUR/USD correction lower to be temporary.

Key quotes

“We are more inclined to view the price action as a temporary correction lower rather than the start of a more sustained reversal. It also fits with the usual seasonal pattern for EUR/USD performance. The US dollar tends to underperform in December and then rebounds in January. We expect the pair to begin to consolidate at higher levels in the month ahead.”

“The main trigger for the short-term correction lower for EUR/USD has been a shift in US fiscal policy expectations. The incoming Biden administration is now expected to deliver a bigger stimulus having won a narrow majority in the Senate. The Fed has moved quickly though to dampen expectations for a faster pace of QE tapering in response to looser fiscal policy. The Fed’s commitment to maintain loose policy should prevent a more sustainable rebound for the US dollar at the current juncture.”

“There is an increased risk that the Italian government led by Prime Minister Conte will not be able to survive after the Viva Italia party withdrew their support over differences on the recovery plan and ESM borrowing. The re-emergence of political risk in Italy has had limited negative impact so far in the Italian debt market. The ECB’s €1.85 trillion PEPP is expected to contain upward pressure on Italian yields, and should thereby help to limit downside risks for the euro as well in the near-term.”