EUR/USD: Focus shifts to Dollar weakness – Commerzbank

FXStreet Insights Team FXStreet

Commerzbank’s Thu Lan Nguyen notes that EUR/USD has nearly returned to pre-war levels as the Euro (EUR) proves resilient and the US Dollar (USD) retreats. Markets expect the European Central Bank (ECB) to hike in June, but Nguyen doubts pricing for three hikes by year-end. He argues that sustained EUR/USD upside should rely more on ongoing USD weakness than on further Euro strength.

Euro resilience versus softening Dollar

"By the end of last week, the EUR/USD exchange rate was trading almost back at pre-war levels. And this despite the fact that the Strait of Hormuz remains blocked and the price of a barrel of Brent crude continues to trade well above the $100 mark. Our currency indices (which measure the performance of currencies against the average of G10 currencies) show that this is due to a combination of USD weakness and EUR strength."

"We have pointed out here on several occasions that this can largely be explained by the fact that the market believes the ECB will respond to the energy shock much more quickly and forcefully this time than it did in 2022. Given the central bank's remarks last Thursday, this belief is likely to persist for the time being. For even if the central bankers have not yet taken action, the ECB President has sent quite clear signals of an interest rate hike in June."

"However, one thing should also be clear: An interest rate hike alone does not justify sustained euro strength - 25 basis points more or less in carry is insignificant. It will depend on how the ECB frames the move: Does it signal a clear willingness to raise rates further? If so, the market is likely to stick to its expectation of further hikes, and the euro would benefit."

"We remain skeptical regarding the market’s high expectations for three rate hikes by year-end. Unless the Strait of Hormuz remains closed until year-end, it is likely to remain at just one hike - both the economic burden from the energy price shock and the pressure from the high debt burden are likely to be too great (especially since the latter threatens to rise in light of potential fiscal stimulus measures)."

"So, anyone looking to bet on higher EUR/USD levels should focus primarily on USD weakness, not EUR strength."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)

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FXStreet Insights Team

FXStreet

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