EUR/USD: More of the same? - Rabobank

The news that drove a surge in the value of EUR/USD yesterday was in many respects a précised form of the events that are responsible for an 8% rise in the value of EUR/USD since the start of the year, feels the analysis team at Rabobank.

Key Quotes

“In contrast to the final weeks of last year political news is clearly favouring the EUR rather than the USD.  The same can be said regarding economic developments.  The US economy may still be functioning well.  However, relative to market expectations that were being built towards the end of last year, recent developments have been disappointing.  Data such as US durable goods, PMI and inflation expectations have been among the latest releases to miss the mark.  At the end of this week, the market is expecting the May US PCE inflation measure to register a softening of price pressures.  The flattening in the US yield curve illustrates the market’s disappointment with respect to the US inflation outlook.  It also highlights investors’ scepticism in the Fed’s guidance that it can hike once more in 2017 and three times next year.”  

“Just as the market is winding back its expectations of Fed tightening, it is also adjusting its view regarding the continuation of monetary policy accommodation from the ECB.  Despite clear concern from German officials regarding the quantity of ECB policy stimulus, Draghi’s tone has tended to be dovish this year.  Up until yesterday, the ECB President had thrown just a few crumbs to EUR bulls by acknowledging the better economic backdrop.  However, the persistence of low core inflation in the Eurozone had ensured that his tone remained cautious.”

“In a step back from this position, Draghi yesterday remarked that “all the signs now point to a strengthening and broadening recovery in the Euro-area”.  We expect the ECB to taper its QE programme in 2018 and while we do not expect the Governing Council to be in any rush to hike rates, the fact that this debate about ECB monetary policy even exists is a significant departure from market expectations that persisted at the end of last year.”

“In our view EUR/USD has the potential to move towards 1.17 on a 12 mth view.  From a technical perspective, this week’s break above the early June top of 1.1285/84 level suggest that the next key level to watch is the 2016 high at 1.1616 set in May with the June 2016 high at 1.1428 a valid short-term target.”

“To expect a sustainable reversal of the move lower from the 2014 high to the 2015 low, EUR/USD would have to break above the Fibonacci 38.2% retracement at 1.1736 and the August 2015 high at 1.1714.  While the 1.17/1.17.35 area is likely to prove to be a significant hurdle, we do see scope for EUR/USD to move higher on an 18-24 mth view assuming a less dovish ECB policy and a slowdown in the pace of Fed tightening.  This view garners support from estimates of purchasing power parity, many of which imply that the EUR is significantly undervalued vs. the USD.  The OECD’s estimate of PPP for EUR/USD currently stands at 1.34.”