Big Picture: Investor sentiment has been undermined by tensions related to Crimea and concern over China’s economic growth. We do not expect the Crimea tensions to evolve into full military conflict or to lead to Iran-style sanctions that would impact energy supply. In addition, we also think that China’s growth rate will not fall dramatically. Overall, our conviction remains that prospects for the global economy remain positive and that economic data will soon turn up as they shake off the impact of special factors.
Interest rates: ECB officials were falling over each other last week to talk down the euro exchange rate. However the rise since the ECB’s Governing Council meeting earlier this month is not big enough to materially change the inflation outlook. Ultimately, we think the euro would need to rise further – possibly in the 1.42-1.44 range versus the dollar – to trigger action by the ECB. We suspect that this would come in the form of a rate cut. Ultimately, the ECB may get relief from across the Atlantic, as improving US data support the dollar.
FX: We have revised our forecasts for EUR/USD significantly higher, though we still expect the direction to be lower. In the near term, euro supportive drivers such as demand for peripheral bonds, LTRO repayments and selective safe-haven support will partly offset the impact of a strengthening of US economic data on the cross, resulting in only a modest fall. However, we expect a stronger appreciation of the USD versus the EUR in Q4 2014, which will gain momentum in 2015, as Fed rate hike expectations become increasingly dominant.