The focus on relative policy has intensified a the FOMC minutes confirm the Fed’s intention to convey the potential for a December lift-off, while ECB statements continue to point to the reassessment of policy in December with the likelihood of further easing measures, notes Morgan Stanley.
"Our FX Drivers model also shows an increased sensitivity of currency markets to policy generally, as well as some specific cases.
…but other factors matter. EUR/USD stands out as driven by policy, with the ECB-Fed divergence pointing lower for the pair," MS argues.
"However, we suggest other factors – the global risk environment and commodity market performance – also need to be taken into account to identify specific opportunities and risks in FX markets. This is even the case for EUR/USD. A more challenging risk environment and increased asset market volatility could limit EUR/USD downside," MS adds.
"Even a EUR/USD rebound is possible in a market risk-off event given the EUR’s inverse relationship to asset markets. We are cautiously bearish EUR/USD as our targets are approached," MS advises.
MS targets EUR/USD at 1.06 by year-end and at 1.03 by Q1'16.
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