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EUR/USD has certainly recovered on the back of optimism for Greece as well as USD weakness.

This does not deter the team at Goldman Sachs, which sees the pair going well below parity:

Here is their view, courtesy of eFXnews:

In a special note to clients today, Goldman Sachs discusses the reasons behind the current low conviction levels that EUR/USD can resume its downtrend. GS provides a counter-argument for each of these reasons concluding that a plenty of EUR/USD downside is still on the cards projecting that the hurdle to go through 1.05 is relatively low in coming weeks.

The following are the key points in GS’ note along with its latest EUR/USD forecasts.

Conviction levels that the Euro can resume its downtrend are as low as we can remember. Most see the single currency in a range near current levels, with the current account surplus, the rise in oil prices and valuation preventing another meaningful leg lower. We do not think it is these things that are at play; in fact, we disagree with each of them on a conceptual level,” GS argues.

The current account: “exchange rates, like other market prices, are forward looking. They reflect expectations for the future, including the likely level of the current account. The mere presence of a current account surplus (or deficit) therefore does not mean that a currency strengthens (or weakens), because this is already in the price. Instead, what matters is the delta, i.e. whether the current account comes in stronger or weaker than expected… The net effect, in delta terms, looks unclear to us – our European team forecast a stable current account surplus through 2015/16 – and likely EUR/$ neutral,” GS clarifies.

The rise in oil prices: “core inflation in the Euro area was trending down long before the drop in oil prices, a reflection of structural reforms on the periphery (that aim to improve competitiveness through internal devaluation) and large output gaps. Core HICP is likely to stay near current levels in coming months, even as headline inflation rebounds further, and this is likely to see the ECB shift its focus back to core (away from headline). This should see EUR/$ weaken,” GS adds.

Valuation: “the Euro is now arguably cheap on some metrics. Indeed, GSDEER says that fair value for EUR/$ is 1.22, so that we are currently in “cheap” territory for the first time in many years. In our minds, fair value only matters if it acts as an attractor, i.e. if it means that it exerts a force of gravity when EUR/$ undershoots it. There is no empirical evidence that this is the case. In fact, the only thing that is clear about fair value models is that exchange rates in practice over- or undershoot them, but never converge to them. We again see this discussion as a sideshow for EUR/$,” GS argues.

Risk-reward favors lower EUR/USD:

“Rather than put much weight on these factors, we think the path of EUR/$ in recent months is a simple (and fairly straightforward) reflection of US data surprises. In short, we think the range from 1.14 to 1.05 is largely a reflection of US data surprises and see risk reward as tilted in favour of EUR/$ lower given our expectation for US data to pick up. In fact, we think the hurdle to go through 1.05 is relatively low in coming weeks,” GS projects.

USD/JPY as a template:

Stepping back from these near-term considerations, we think the history of $/JPY offers an interesting template for where we now are in EUR/$. Back in June 2013, just after the start of QQE in Japan, the market also had a crisis of confidence that Yen weakness could continue. Those doubts have long gone, given the severity of low inflation in Japan. If anything, given its structural problems, the low inflation challenge in the Euro area could be more ingrained than in Japan, which is why we still see – in the bigger picture – plenty of downside for EUR/$,” GS clarifies

EUR/USD forecasts:

Our 12-month forecast remains 0.95 and we expect 0.80 by 2017,” GS projects.

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