Fed Meeting to cap EUR/USD upside near term – Danske Bank

With a Fed set to confirm its intentions to hike rates once more this year and in light of a market that is clearly not prepared for this, it would be tempting to conclude that EUR/USD should come lower near term, according to analysts at Danske Bank.

Key Quotes:

“But not so fast: relative short-end rates have not been a key driver of the FX market in the year so far – rather ‘euro optimism’ and an associated shift in ECB policy have been essential for the cross. That said, speculative positioning is closing in on stretched levels for EUR/USD longs, suggesting the vulnerability of the FX market to USD-positive news is greater than ‘normal’ at present. Thus, if US activity continues to surprise on the upside in Q4 – as our quantitative business-cycle model suggests it will – the pricing of a December hike could gain traction, and the FX market is unlikely to be immune to this”

“Fed balance-sheet reduction should not play a major role for USD crosses spot near term as it is well anticipated and as a rebuild of the Treasury cash buffer (which could add to tighter USD liquidity) has now been postponed. Even if ‘pockets’ of USD strength could materialise near term, we note that it is currently somewhat difficult for the market to send US yields higher due to the weak inflation prints recently, i.e. a key Fed obstacle. Thus, we reiterate our call that any dips in EUR/USD will be shallow and short-lived, but, at the same time, emphasise that the speed with which EUR/USD is set to move higher will be reduced going forward.”