The Euro-Dollar exchange rate has room to edge higher as Fed hike expectations retreat, but Rabobank sees the move as largely Dollar-driven and doubts investors will rebuild large EUR longs.
The Euro-to-Dollar exchange rate (EUR/USD) was trading around 1.1545 on Tuesday after ending last week close to its highest levels since mid-June.
Foreign exchange analysts at Rabobank have responded by bringing forward its 1.16 forecast from six months to three months, but the bank is careful not to read the latest rise as evidence of broad Euro strength.
“This may give the illusion of a buoyant EUR,” Rabobank said. “The move, however, was driven mostly by the USD.”
That distinction is borne out by relative performance.
The Euro has sat around the middle of the G10 pack over the past week and remains the third-worst performer over both the year-to-date and half-year periods.
The decisive catalyst for EUR/USD was the unexpectedly weak US July payrolls report.
“The softer data dealt a blow to expectations of Fed rate hikes which knocked US yields and the greenback lower,” Rabobank said.
The bank expects the Federal Reserve to leave rates unchanged this year, a view which “suggests scope for further softness in the USD”.
EUR/USD has recovered sharply from late-July lows near 1.1370 and is now trading close to 1.1550.
Europe itself has held up better than many expected.
Eurozone GDP grew 0.4% quarter-on-quarter in Q2, twice the consensus forecast, while the July composite PMI rose to 51.9 from 50.0.
Rabobank said the economy had “weathered the headwinds better than expected”, despite higher energy prices and disruption around the Strait of Hormuz.
There are still plenty of reasons for caution.
Germany’s unemployment rate rose to 6.4% in July, while softer real compensation growth suggests household spending could stagnate through the rest of the year.
And a stronger Euro is not necessarily welcome for exporters already dealing with weak external demand and intense Chinese competition.
Near-Term EUR/USD Outlook: 1.16 Now a Three-Month Target
Rabobank also thinks another ECB rate hike offers limited help for the currency because markets have already priced much of it in.
“Given that another ECB rate hike is already in the price, a move is unlikely to provide much additional upside incentive for the EUR,” the bank said.
Its forecast therefore relies more heavily on the US side.
“We see scope for a modest upside bias in EUR/USD in the months ahead, mostly reflecting a reduction in Fed rate hike speculation,” Rabobank said.
“We have brought forward our forecast of a move to 1.16 from 6mths to 3mth.”
That is hardly a call for a runaway Euro rally.
“In the absence of upside growth surprises in Q3, we are doubtful that the market will be keen to rebuild substantial EUR long positions in the coming months.”
EUR/USD can grind higher towards 1.16, but unless Eurozone growth surprises positively, the move is likely to remain more about a softer Dollar than a genuinely stronger Euro.
