USD to withstand AI valuation concerns
US government shutdown ends and markets await fresh data flow
The resolution of the US government shutdown has ended the data vacuum that left the Fed and markets 'driving in a fog'. FX markets have struggled to find clear direction, with many pairs trading largely rangebound. Hawkish comments from Fed members have led markets to price a coinflip between a rate cut and a hold at the December meeting. Thus, incoming US data will be pivotal for shaping sentiment in the weeks ahead. Risk sentiment has been mixed. Initial optimism stemmed from solid Q3 tech earnings, a sustained disinflationary trend, and tailwinds from the shutdown resolution. However, caution has since returned, as cross-asset moves showed equities lower, yields higher and the dollar weaker. Notably, the dollar deviated from its usual safe-haven behaviour, with FX impacts most pronounced in risk-sensitive currencies. This shift likely reflects valuation-driven positioning in the AI and tech sectors, as portfolio flows remain a key driver of US capital movements.
Over the past month, EUR/USD has traded in the 1.1500-1.1650 range with intra-range moves largely following US announcements on the government shutdown and AI/Tech equity movements. Scandies have also been trading sideways despite contrasting macro developments: Sweden with stronger fundamentals versus Norway's softer data. Notably, US real rates have served as a proxy for the pairs, creating a high sensitivity to the soon-to-be-released US data. The Japanese yen was last month's weakest G10 performer, with USD/JPY trading near 157.
Outlook: Positive on EUR/USD and EUR/Scandies
We continue to see EUR/USD on an upward trajectory, targeting 1.22 on a 12M horizon, supported by rate differentials, a recovering European asset market, reduced global demand for restrictive policy, ongoing tailwinds from hedge ratio adjustments, and waning confidence in US institutions. Meanwhile, in the near term, the balance of risks remains tilted toward USD strength via higher USD real rates. For EUR/SEK, we stick to our 1M 11.00 target as year-end approaches, with a tug-of-war between seasonality pulling lower and relative rates, including US dittos, skewing risks higher. For EUR/NOK, we remain positive long-term, as Norway's divergence in relative unit labour costs sustains real appreciation pressure on the NOK which requires a higher EUR/NOK over time. In the short term, US data and Q4 risks pose topside risks for the cross.
Risks to our forecasts are predominantly tied to the US outlook. If the capital rotation out of US assets continues and a sharp US recession hits, EUR/USD could break substantially higher than our forecast suggests. In this environment, commodity currencies would also face a larger hit. Conversely, persistent resilient US data and/or renewed euro area weakness that could prompt the ECB to cut again this year could keep the USD stronger-for-longer. We highlight that a stagflationary shock to the US economy might not necessarily be positive for the USD - even if the Fed refrains from cutting rates (or delivers hikes) - as the US investment case in such a scenario would suffer.
Author
Danske Research Team
Danske Bank A/S
Research is part of Danske Bank Markets and operate as Danske Bank's research department. The department monitors financial markets and economic trends of relevance to Danske Bank Markets and its clients.
