EUR/USD: Limited upside as longer-term Dollar risks grow – Commerzbank

Commerzbank’s Thu Lan Nguyen argues that in the short term EUR/USD gains are capped as markets may be overestimating the European Central Bank's (ECB) reaction to the latest inflation shock. She notes the Euro (EUR) and Pound (GBP) have held up better than in 2022 thanks to expectations of quicker tightening. Over the longer term, she highlights greater inflation and policy risks for the US Dollar (USD) versus the Euro.

Short-term cap, longer-term Dollar risk

"How will the fx markets develop in this environment? I think it makes sense to distinguish between the short and the longer term. In the short term – and we have already seen this to some extent – the focus is likely to be very much on the immediate reactions of the central banks."

"This time things look a little different. The euro, and alongside it the British pound, are holding up fairly well against the US dollar. This is probably because markets trust both the ECB and the Bank of England to have learned from the mistakes of four years ago and to react early to inflation risks."

"We have already expressed our doubts about market expectations for the ECB on several occasions, which is why we see the further upside potential in EUR/USD as limited. But that is only the short-term view. In the longer term, the pendulum could swing back again."

"Therefore, in the longer term, the wheat is likely to be separated from the chaff, and only those currencies will prove robust where inflation falls back towards the 2% target more quickly. We see substantial risks in particular for the dollar. Apart from inflation, which has recently been firmer anyway due to the significant increases in import tariffs, further attacks by the US government are likely to make it difficult for the US central bank to respond adequately to an inflation shock."

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