Euro Forecast to Enjoy Strong Rally by Morgan Stanley
A mid-year assessment of the foreign exchange markets by analysts at one of the world's leading investment banks have come out in full support of the Euro.
The single currency is seen moving higher against the Pound and Dollar amidst a solid improvement in Eurozone fundamentals and political stability.
The Euro has gained ground since Emmanuelle Macron beat Marine Le Pen in the first round of the French Presidential election on the 23rd of April.
EUR/USD gapped higher on the Monday after the election as the Eurozone breathed a collective sigh of relief.
The main threat to the integrity of the Eurozone was all but gone: gaps in financial markets normally fill quite quickly but this one is still open due to the step change it marks in the level of political risk for the region.
If Le Pen had won the election the Euro would have been in peril, but as it is, if anything the opposite has occurred: there has been a retrenchment in the ideology of a united Europe by the European political elite.
Macron is a staunch advocate of the European Union and his victory seals, to a certain degree its continuity, but it also arguably goes further.
With the anti-Euro PPV in Holland and Le Pen in France defeated, the masters of European integration may be emboldened to take the project a step further and seek deeper integration.
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German Election: The Last Hurdle
The last major hurdle to forwarding their plans is the German General Election on September 24 (and possibly the Italian election, likely to be held in spring 2018, but possibly sooner).
Analysts at Morgan Stanley see the German election as a major turning point for Europe and for the Euro.
“Once the German election (September 24) is out of the way, markets will watch whether the new German government makes any concessions, bringing forward EMU’s financial and fiscal integration process. If it does, EUR may move higher than we currently project,” said Morgan Stanley’s chief strategist, Hans Redeker.
The prospect of a deeper fiscal and financial union of the Eurozone will push the Euro substantially higher.
The lack of deeper integration has acted as depressor on the European Central Bank (ECB), who have been forced to overlook the recovery in more successful members and set monetary policy at a level supportive of struggling member states instead.
The ECB has had to keep interest rates abnormally low which has weighed on the Euro. Interest rates are a major driver of currencies, the higher the interest rates the stronger the currency, because high rates attract more inflows from overseas.
Redeker makes the distinction between an ‘optimal currency area’ where regional interest rates reflect regional economic conditions, and a ‘sub-optimal area’ like the Eurozone, where a one size-fits-all rate set in Frankfurt must apply across the whole area.
“Within an optimal currency area, regional real rates should reflect regional investment and productivity growth. Increasingly, this was not the case within the eurozone, leaving the ECB little choice other than applying monetary policy for its weakest relevant link," says Redeker.
Hence, it did not surprise the analyst to see EUR trading at levels indicated by Italian fundamentals instead of those equivalent to broader eurozone fundamentals.
"The opposite is now occurring for the EUR. Signs that eurozone leaders are moving toward fiscal integration should boost the common currency,” says Redeker.
Global Risk Appetite To Help the Euro
But this is not the only reason Morgan Stanley are positive about the prospects of the single currency, the other is global growth.
Analysts at the bank are confident that global growth is set to rise:
“We expect the global economy to pick up and for risk to remain supported over the coming year. Combined with a still high degree of monetary accommodation from DM central banks, we expect USD to weaken moderately and EM FX to stay supported,” say analysts at the bank.
This, combined with a complete reversal of the Euro’s relationship to risk has improved the outlook for the single currency.
Previously the Euro had responded inversely to risk appetite – falling when the market is confident and rising when it is fearful - but Morgan Stanley see this relationship reversing.
“EUR has turned into a pro-risk currency, rallying when growth expectations rise as foreign equity inflows pick up, and our EURUSD and EUR cross projections reflect this outlook. JPY and CHF should weaken in line with equity market strength,” said the bank.
The success of the global economy is likely to reflect positively on the economy of the Eurozone.
The Euro-area is a net exporter so increasing demand from countries abroad will fill company coffers back in Europe.
This in turn should drive up European share prices thus attracting money from foreign investors abroad, and these inflows will increase demand for the Euro.
In fact, demand for European equities is already boosting the single currency, especially because most of the investments are unhedged, and are therfore not offset by Euro-selling.
This also further indicates widespread confidence that the Euro will appreciate.
Forecasts
January’s EUR/USD 1.03 lows were a definitive bottom for Morgan Stanley who don’t see these being surpassed.
Instead they forecast the pair to rally to 1.19 by Q1 2018.
The expect the ECB to start tapering accommodation early in 2018.
