Will the EUR/USD finally fall?
The ECB turned around the direction in EUR/USD with the announcement of more monetary stimulus including negative interest rates. This hurt the euro. The movement in EUR/USD, however, has lost momentum. One the one hand, this partly reflects developments on the EONIA curve. It appears that eurozone banks are currently adjusting their liquidity management to profit the most from the announced ECB measures. This has supported the euro despite the divergence in 3, 5 and 10Y yields across the Atlantic. Going forward, we expect that the dovish forward guidance by the ECB and the TLTROs will result in a downward adjustment of the market’s view about the EONIA curve. In turn this should hurt the euro. The ECB’s forward guidance that rates will remain low for a long time means the euro is now a currency to avoid unless you want to borrow. On the other hand, the US dollar has also come under pressure recently. A combination of a dovish Fed, lower US real yields, doubts about the US economy and higher oil prices have acted as serious headwinds for the US dollar. Despite the dovish remarks from the Fed at the latest meeting, we continue to expect that better than expected US data will result in an upward adjustment in interest rate expectations for 2015. If the US economy continues to improve, it will be difficult for the Fed to signal that inflationary pressures are just noise. Therefore, when the Fed comes closer to achieving its dual mandate, the forward guidance will also change. We expect the Fed to shift to a more hawkish stance later in the year, which should support the dollar across the board and push EUR/USD lower.
Some adjustments in our high conviction views
We keep most of our high conviction views in place, but we took profit on our long sterling position versus the euro and closed our long euro position versus the Swiss franc. For starters, markets have now gone a long way in pricing in the scenario of the Bank of England being the first major central bank to raise rates. Therefore, the upside in short-term interest rates and the sterling is relatively limited in the near term. Speculative net sterling long positions in the futures market are close to a five year high. It is likely that these positions will dampen sterling’s upside. In fact, they make sterling vulnerable and could lead to asymmetric reactions to events and data. On balance, the risk-return trade off no longer favours sterling. Therefore, we closed our long sterling position versus the euro (short EUR/GBP) on 16 June with a total return of 5% (see Global Daily Insight of 16 June). In addition, we have also closed our short EUR/CHF trade with a loss of around 1.4% in total return terms. The change in the ECB monetary policy will make it unlikely that the euro will strongly outperform the Swiss franc if investor sentiment improves further. Furthermore, the Swiss franc has recently proved to be more resilient in case of waves of risk aversion. We have kept our other high conviction views in place. We remain negative on the euro, the Japanese yen and the Swiss franc (versus the US dollar), while we remain positive on the US dollar, Mexican peso (versus the US dollar), Polish zloty (versus the euro) and Swedish krona (versus the euro).