Commerzbank: Euro-Dollar "Levels Below 1.20 are Justified"

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Levels below 1.30 in the Euro-to-Dollar exchange rate (EUR/USD) are said to be justified by foreign exchange analysts at Germany's Commerzbank, although they add moves below 1.18 would not be.

In a weekly research briefing note to clients, Ulrich Leuchtmann, Head of FX Research at Commerzbank, says following the publication of the latest FOMC projections, the dollar gained significantly.

"The USD reaction is justified," says Leuchtmann.

The Federal Reserve (Fed) brought forward the time they believed interest rates might rise for the first time to 2023, from 2024 previously.

The move is however regarded as being one that is entirely consistent with the market's own expectation for the timing of the rate hike.

Leuchtmann says the Fed is therefore right to mirror the market's expectations, particularly given they now operate within a new policy paradigm where they not only seek to manage inflation but also employment.

Above: The market's Fed expectations: in agreement with the Fed funds rate, Fed target range and OIS-based market expectations; percent. Image courtesy of Commerzbank.

"It has become clear that the market is correctly assessing the Fed's intentions. This has reduced the risk of the Fed, with its new, untested strategy and in view of the unusual conditions, acting quite differently from what the market anticipates," says Leuchtmann.

The Dollar rose against all its peers in the wake of Wednesday's policy announcement and pushed the EUR/USD rate below 1.20.

In fact, the U.S. Dollar is now the month's leading gainer, having advanced against all the G10 currencies over the course of a 30-day period:

"EUR-USD at 1.20 should be justified. Price targets below (say:) 1.18 would not be. If EUR-USD were to fall lower, I would classify that as overshooting and go for correction," says Leuchtmann.

With the Dollar strength pushing EUR/USD back to 1.19 there is a risk that this lower-bound target at 1.18 is triggered in short order.

"Admittedly, the current moderate USD strength may continue for a while," says Leuchtmann.

Commerzbank analysts are expecting the Dollar to ultimately settle down once it becomes clear that that inflation expectations in the U.S. are revised downward, which they believe will be the case on a longer-term basis.

Above: Long-term market-based US inflation expectations lower. Pecent year on year, from inflation swaps. Image courtesy of Commerzbank.

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