Euro-Dollar Breaks Below 1.20 as 'U.S. Exceptionalism' Returns

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• EUR/USD spot at publication: 1.1985
• Bank transfer rates (indicative guide): 1.1560-1.1650
• FX transfer specialist rates (indicative): 1.1900
• More information on specialist rates, here

The Euro-to-Dollar exchange rate (EUR/USD) has fallen below the magic marker level of 1.20 on Thursday amidst a strong rally by the Dollar right across the board, in a move that some are saying reflects a fundamental reality that the U.S. economy is outpacing that of the Eurozone and other peers once more.

The EUR/USD went to 1.1999, the first sub-1.20 reading since December 01 in a move that was foreseen by some technical analysts we follow.

Importantly, they say a break below 1.20 could open the door to a more rapid decline in valuation for the exchange rate.

"EUR/USD is tracing out a textbook head and shoulders with low volatility," says Brent Donnelly, Spot Trader at HSBC in New York, citing the following chart:

"Last year’s high was 1.2014 so that level is the last line of major support if we are still in an uptrend for EUR/USD. A break through 1.2000 should trigger a huge wave of capitulation from human and system traders," says Donnelly.

The Euro has come under pressure of late owing to some fundamentally-justified concerns, notably the the slow vaccine rollout in the area that could mean it exits lockdown well behind the UK and U.S.

But even in a world without vaccines, the EU economy is struggling and the U.S. has outperformed, an outperformance that can only increase given 1) cases in the U.S. are already coming down 2) lockdown measures in the U.S. as a whole are markedly less stringent than is the case in the Eurozone and 3) a big wad of cash is going to soon make its way into the bank accounts of U.S. citizens.

"Markets are taking another look at the USD and questioning whether increased fiscal stimulus after the Democrat’s blue wave success will mean yield support for the USD or the prospect of an improved economic pick-up," says Ray Attrill, Head of FX Strategy at NAB.

U.S. economic outperformance is therefore back, and it is helping the Dollar advance.

"The USD’s resilience to the recent rally in equities has rejuvenated the 'US exceptionalism' theme," says Daragh Maher, Head of U.S. FX Strategy at HSBC.

"We expect relative economic growth to become a greater part of the narrative as the grip of risk appetite on FX fades through the year. So we subscribe to the idea that US exceptionalism will play its part in FX, but we are less convinced that it is already over-shadowing risk appetite as the main driver," he adds.

Above: EUR/USD has gone below the 1.20 marker once more.

The outperformance theme is given credence by the observation that the Dollar is rising alongside stock markets, creating a correlation that has been absent over recent months given the Dollar has tended to weaken when markets were rising and investors were in a 'risk on' mood.

"When risk is dominant, the USD more often moves in the opposite direction to equity markets," says Maher. "In the last year and last quarter, this happened on 55% and 56% of occasions, respectively. So far this year, the ratio is 50%, suggesting risk and growth are in a battle for the USD."

The economic performance of the U.S. relative to the Eurozone cannot be ignored as the consensus forecast for 2021 GDP growth in the U.S. has moved to 4.1% from 3.8% back in December.

Real GDP in the Eurozone is meanwhile projected to rebound from -7.3% in 2020 to 3.9% in 2021 by the European Central Bank, according to their latest December forecasts.

Data out this week confirmed the eurozone economy fell into a double-dip contraction in the final quarter of last year, shrinking 0.7% from the previous three months.

The Eurozone economy's sluggish end to 2020 has meanwhile been reflected in the pace of growth of the European Central Bank's balance sheet, which has grown faster than that of the Fed owing to quantitative easing.

Above: The ECB has out-printed the Fed since summer says Nordea Markets.

Some analysts say this matters as the currency's tend to respond to the scale of quantitative easing in one region relative to the other. Nordea Markets noted this divergence this week, and say one model would suggest that the EUR/USD exchange rate's fair value resides down at 1.17.

Politics remain a concern for some analysts, who note the sluggish rollout of the coronavirus vaccine is placing pressure on the European Commission and fraying internal politics.

Of note, Germany’s grand coalition is now reportedly under stress as vaccine tensions grow with the Social Democrats are said to be seeking to distance themselves from Merkel’s CDU over the pandemic.

"Entering a critical election year, and amid growing anger at European vaccine shortages, Germany’s Social Democrats are making a risky political play: they are turning against their own partner in government," says the FT.

"We downgrade our expectations for EUR to price in a higher risk premium for political strife and economic underperformance both short term," says Shahab Jalinoos, a trading strategist at Credit Suisse.

Credit Suisse downgrade their Euro-Dollar exchange rate forecast and look for an EUR/USD range of 1.1850 – 1.2350 for the rest of the first quarter of 2021, down from their long-held 1.2000 - 1.2500 call.

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