EUR/ USD: Multi-year 1.05-1.15 range will hold – Deutsche Bank

George Saravelos, Research Analyst at Deutsche Bank, suggests that they think the top end of the multi-year 1.05-1.15 EUR/ USD range will hold and would fade euro strength as the top end of the range approaches.

Key Quotes

“European data surprises are at extremes

European data has been impressive but data surprises are now approaching extremes relative to the US. From current levels the risk is that US data improves over Europe. Relative data surprises have done a good job of tracking relative European – US equity performance suggesting this may be at risk of peaking too.”

“A soft ECB taper is already priced

An early hiking cycle from the ECB would have been a game-changer for the euro. But recent ECB commentary has confirmed “American-style” sequencing with tapering coming first. The Fed experience showed us that this is not particularly bullish for a currency. The euro has already appreciated by a similar size to the dollar around Fed taper in 2013. After the initial dollar rally the greenback weakened over most of that year.”

“The euro is completely mispriced to short-end rates

The correlation between front-end rates and the euro has broken down but this has historically been a powerful driver and is pointing lower. Historical experience suggests that as the dollar climbs the global yield ranking it should find increasing support as a high-yielder too.”

“Market consensus has turned bullish euro

The risk reversal, a measure of market demand for EUR/USD calls over puts has turned to the highest level since 2009 pricing out all downside risks to the euro. Positioning has also been building with the CFCT non-commercial long at the top 25th percentile since 1999. Positioning is vulnerable to negative European data surprises and politics too: an early autumn Italian election cannot be ruled out.”

“Equity inflows are approaching previous peaks

Unhedged foreign equity inflows have been a key support for the euro in recent weeks but the gap to previous peaks is quickly closing. Relative European-US equity valuations have already adjusted quickly with the relative European-US P/ E ratio on the MSCI now one-standard deviation above its ten year average.”

“The Fed is very underpriced

The market is only pricing one rate hike from the Fed next year compared to a 75bps Fed baseline and at a time when financial conditions are exceptionally easy. Balance sheet policy is also mis-priced with US and European 5y5y real rates at similar levels: either ECB pricing is too hawkish or Fed too dovish but similar real rates in Europe and the US do not make sense.”

“Where could we be wrong?

Surprise European inflation triggering a more aggressive ECB tightening or unanticipated Trump risk: an impeachment that causes complete US political paralysis/fiscal tightening or a Fed Chair appointment that completely changes the FOMC reaction function.”