EUR/USD to witness two discrete ECB-driven jumps - ING

Petr Krpata, Chief EMEA FX and IR Strategist at ING, suggests that they are revising their already constructive EUR/USD forecast higher, looking for two discrete “jumps” in EUR/USD – one this year, the second next year and they expect EUR/USD to reach 1.15 in 3Q this year and be at 1.20 around mid-2018.

Key Quotes

“The dissolution of the French election risk will allow market participants to fully focus on the next key theme in FX markets the ECB QE tapering – which should be EUR positive and lead to the first one-off discrete jump from the current 1.10 to the 1.15 level.”

“As was the case during the US taper tantrum in 2013, we expect long dated EZ yields to increase meaningfully in response to the market anticipating a lower pace of ECB purchases, in turn directly benefiting EUR (similar to the 2Q15 period when Bunds sold off and EUR/USD rallied).”

“Thereafter, we expect EUR/USD to stabilize around the 1.15 “gravity line” (with frequent over and undershoots – the latter most likely around the end of this year, when market participants start becoming concerned with Italian election risk).”

“After a period of stability, we look for the second discrete jump in EUR/USD to 1.20 around mid-2018 when the second leg of the ECB monetary policy normalisation kicks in (given that the ECB will be closer to lifting the deposit rate). This should lead to a meaningful rise in short-dated German and EZ yields – to the benefit of the EUR.”

“The 5 big figures increase in EUR/USD in 2018 is consistent with our model simulation of the narrowing US-EZ short-end rate spread and its spill over in EUR/USD.”

“While we expect the Fed to continue raising rates, we note that the market already prices in 44bp of a Fed funds rate hikes this year. This means a limited room for an upside USD and that EUR/USD should be primarily driven by the EUR leg.”

“The two step ECB monetary policy normalisation (the end of QE, then the deposit rate hike) will throw the profound EUR/USD undervaluation into sharp relief, with the cross being 12% undervalued. Valuation should change from being a “limiting” factor (limiting the EUR fall in past years) into an “amplifying” factor facilitating a EUR rebound.”

“While we don’t underestimate the EZ political risk around 1Q18 Italian elections (at that time we see downside risks to our EUR/USD 1.15 forecast), we note the diminishing impact on the EUR of various EZ political crises over recent years. We expect EZ political risk premia to be more reflected in the EUR derivative market than EUR spot.”

“The rise of the EUR/USD should be a large positive for G10 European currencies versus their dollar peers as the strong EUR will lift all tides in Europe. Short USD/SEK positions should do well, partly due to the insufficient Riksbank extension of its QE.”