Our Euro-Dollar Forecast of 1.05 Could be "Too Optimistic" Says JPMorgan

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"Is our EUR/USD target of 1.05 too optimistic?" asks Meera Chandan, FX Strategist at JPMorgan in a recent currency market update.

The query comes alongside updated research that sees the investment bank consider a lower range for the Euro to Dollar exchange rate in the wake of the recent deterioration in Eurozone economic data and an associated fall in the single currency.

"The euro does not have a discount despite the myriad uncertainties it faces," says Chandan, "cyclical divergence, supply side underperformance, softer terms of trade, narrowing rate differentials and risk market performance - are all suggesting further euro weakness."

JPMorgan's modelling suggests EUR/USD fair value is located between 1.02 and 1.05 when viewed through the lens of relative growth dynamics between the U.S. and Eurozone.

In May analysts at the investment bank highlighted that EUR/USD had started undergoing a regime shift given the marked slide in growth momentum in both the Eurozone and China, which was very much in contrast to the US.

"Hence, our adoption of a bearish view on the euro at that time," says Chandan.

The Euro-Dollar peaked at 1.11 in May but had managed to touch 1.1257 by mid-July, before the determined selloff we are currently witnessing commenced.

The pair is now some 5.0% below those July highs. Declines come alongside softening Eurozone PMIs - with August's release suggesting growth has fallen to 0% - which is well below the European Central Bank's expectation of 1.5%.

The divergence in relative growth momentum with the U.S. is stark, given the ongoing resilience in the U.S. data.

Meanwhile, inflation is falling in both the U.S. and Eurozone, "so is not a source of divergence in the same way," says Chandan.

JP Morgan maintains a year-end target of 1.05 for the Euro-Dollar, which is already amongst the lowest relative to the consensus, "but 1.02-1.03 could be tested if regional weakness deepens."

For EUR/USD fair value to get to parity (not JPMorgan's base case yet), Chandan says the Eurozone would need either another energy price shock or a 60-70bp compression of the rate spreads against the Euro; "alternatively, and perhaps a more doable, 30-40bp spread compression, accompanied by a 2-3% undershoot in the euro as this unfolds".