Euro-to-Dollar Rate Gains Capped here says Barclays, U.S. Dollar "Still the Winner" in 2021 says Danske

- 1.19 is top of the EUR/USD range - Danske Bank
- USD still "the winner"
- EUR/USD gains to be capped - Barclays

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The attractiveness of the United States as a destination for international capital is likely to ensure the Dollar enjoys ongoing demand according to new analysis from Danske Bank, meanwhile analysis from Barclays suggests any upside potential in the EUR/USD exchange rate will be limited from here.

The Euro-to-Dollar exchange rate has rallied back to the top of a multi-week range over the course of November, going from a low of 1.16 on November 04 to current levels around 1.1870.

Those backing further gains by the Euro will be looking at this level as offering some notable resistance and would therefore be wary of a return lower into the range as a result. However, a break above the current area could open the door to 1.20 again:

Above: EUR/USD chart showing 2020 moves and the upper range.

According to Danske Bank, 1.20 would represent a limit for the exchange rate.

The Scandanvian lender has issued a fresh set of foreign exchange forecasts that show while the Euro-to-Dollar exchange rate can nudge back to 1.20 again, the Dollar should remain favoured in 2021.

"Current negative COVID-19 developments cap the topside for now. EUR/USD has moved towards 1.19 on the back of the US election but grinded marginally lower again despite positive vaccine developments," says Lars Merklin, Senior Analyst.

The Euro-Dollar exchange rate reached a low at 1.0630 at the height of the covid-19 market meltdown in March, before embarking on a sustained recovery that took it to the psychologically significant 1.20 level on September 01. The pair has since faded back into a range trade and those watching the market are considering whether this period of consolidation will be resolved with a fresh move higher.

Not so, says Danske Bank who see the next directional move as being lower.

"We still see EUR/USD around 1.20 in 3M but longer term the USD is still 'the winner' and we forecast 1.16 in 12M," says Merklin.

Analysts at Barclays agree.

"Rising virus cases and subsequent worries of more severe near-term economic drawdowns – even with a more constructive outlook in the medium term from vaccine developments – have paused EUR’s rally post the US election. We think some renewed safe-haven demand for the dollar, and the USD’s economic outperformance against Europe, are likely to cap EUR/USD gains," says Wen Yan, a foreign exchange strategist with Barclays in London.

Expectations for a firm Dollar in 2021 contrast notably to those held by Citibank, who told clients on Monday they see U.S. dollar weakening by up to 20% next year.

Analysts at the world's largest prime dealer of foreign exchange say the distribution of vaccines next year will help drive the declines with analysts also seeing the potential for the dollar weakness to be front-loaded.

This suggests the losses in the Dollar will be accelerated and could happen in a relatively swift move.

Citi assume the Federal Reserve will maintain loose monetary policy even if inflation rises alongside economy recovery, allowing U.S. bond yields to rise.

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But looking into 2021, for Danske Bank the U.S. will remain a desirable destination for international capital that should guarantee support for the Dollar.

"Fundamentally, the US should continue to be a high(er) interest rate market and equities continue to appeal to foreign investors. This means the US is likely to attract capital, which generally helps the USD," says Merklin.

Short-term developments have meanwhile failed to deliver the kind of upside impetus in the Euro that might be expected when global investor sentiment has improved.

This week saw biotech firm Moderna announce its vaccine candidate was 95% effective in protecting recipients from covid-19, news that follows on from similar headlines from Pfizer a week prior and added to improved investor sentiment.

With more companies expected to announce successful vaccines, markets are looking forward to an economic recovery in 2021, but trying to gauge what this spells for the Euro and Dollar is still up for debate amongst foreign exchange analysts.

While vaccines are likely to be a feature of 2021, near-term headwinds continue to blow strong, ensuring the need for further easing out of the European Central Bank.

"Markets are also likely to be pricing in more aggressively a dovish ECB, given a comprehensive easing package is expected at the December meeting to counter deflationary pressures," says Yan.

The rule-of-thumb in foreign exchange is that when a central bank eases, the currency it issues declines in value. Additional easing from the ECB is however well signposted to the market and therefore the negative currency impact is likely to be limited.

However, it certainly does not help the Euro-Dollar when the Federal Reserve looks to be leaning in the other direction.

"The Fed has proven itself more hawkish than we expected and, in turn, the USD has strengthened a little," says Merklin. "US real rates have slightly increased vis-à-vis EU peers and this is somewhat USD positive."

Meanwhile, Danske Bank says the ECB is expected to be a slightly negative influence on Euro exchange rates, even thought they are not expected to lower interest rates, nor substantially change the economic path of Europe.

"We suspect the ECB will be a slightly EUR-negative factor in December," says Merklin.

Danske Bank estimates show 'fair value' for EUR/USD to be a 1.08-1.20 range, depending on the model employed.

"Either way, at current levels, valuation is neutral if not an outright headwind for spot," says Merklin, "Until we see a firm change in the macro narrative, EUR/USD is a 1.15-1.19 range."