Jane Foley, Senior FX Strategist at Rabobank, explains that current trends would imply that there are upside risk for EUR/USD beyond their 1.12 one year target but, in view of the risks and the exceptional amount of volatility, Rabobank will hold off from making revisions just yet.

Key Quotes

“On May 12 the FT reported that investors had poured a record USD6 bln of new capital into European stock funds during the previous week.  This ferocious appetite for European assets was also demonstrated in the CFTC speculators’ positioning data which last week recorded a net positive position for the EUR for the first time in 3 years.  The trigger for the better tone was news that Le Pen had failed in her attempt to win the French Presidency.  This brought a flood of relief that populist tendencies had, at least for the time being, been overcome by liberal governments in Europe.”

“Feeding the better tone has been the acknowledgement that the Eurozone economy is performing at better levels that had been generally forecast at the start of the year.  This improvement in perceived economic fundamentals in the Eurozone has come at a time when the Trump Administration has become bogged down by scandal. It also follows a bout of mixed economic data in the US.  A reversal to expectations regarding the Trump reflationary trade may have been the source of the recent softening in the USD.  However, in our view the coincident improvement in the EUR’s outlook has been a catalyst for the softer tone of the greenback.”

“However, the Eurozone boasts a huge current account surplus (around EUR37 bln sa in Mar) which can mean the EUR displays quasi safe haven qualities from time to time.”

“The level of net long USD positions had fallen back to levels last seen in early November 2016 – a time when Clinton was expected to take the White House.  A similar picture is demonstrated by the US effective exchange rate, which has given back the gains made in the final weeks of 2016.  Our view that the US market had priced in too much reflation at the end of last year combined with the likelihood of a relief rally for the EUR after the French Presidential election were key factors behind our relatively bullish forecast for EUR/USD this year.  Our target of EUR/USD1.10 has now been surpassed and our 12 mth forecast of EUR/USD1.12 is already in view. That said, we have so far been slow to push these expectations up another notch.”

“Political risk and economic uncertainty

From the point of view of the EUR, the Italian election (which has to be held by May 2018) could bring another surge of populism to the shores of Europe.  If France’s Macron fails to win a parliamentary majority next month, fears that his reform agenda could stall could also reduce enthusiasm for the EUR. There is also the risk that the market will be disappointed if the ECB maintains a dovish tone at the June 8 policy meeting in respect of still relatively soft core CPI inflation and wage growth in the region.  With respect to the greenback, there is speculation that the Federal Reserve is keen to outline a plan regarding how it intends to tackle balance sheet reduction ahead of the end of Yellen’s term as Fed Chair next spring.”

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