EUR/USD: US Dollar Weakness Temporary, March Lows to be Tested

US dollar profit-taking will likely prove temporary say analysts at Holland’s ABN Amro suggesting rises in the euro / dollar exchange rate should be sold.

On the heels of hawkish sentiments from the FOMC minutes, investors have sought to profit on long USD positions due to the Fed’s gradual and modest hike opinion.

However, this profit taking is temporary, says ABN AMRO.

The bank explains its position, “Net long US dollar positions are sizeable, but far from extreme levels.

“We expect further strength in the US dollar in the coming months as financial markets have not fully priced in that the Fed will raise the Fed funds target rate by 25bp later this year in December. Currently financial markets estimate a probability of 66%. So there is clearly more room.”

“In addition, we expect the ECB to lower the deposit rate by 10bp to -0.3% later this year in December. We expect the ECB to increase the size of its asset purchase program from EUR 60bn a month to EUR 80bn.

“The deadline of the QE program is also likely to be extended beyond September 2016. As a result of this monetary policy divergence, we expect EUR/USD to test the March low just below 1.05. Our year-end forecast is 1.05. We expect the downtrend to continue next year to 0.95.”

After a very lacklustre weak for the embattled currency, the EUR made some slight gains this morning, although it continues to convert at its lowest levels since April of this year.

There were no surprises in yesterday’s release of the Federal Open Market Committee (FOMC) October minutes. Thus, the EUR/USD was able to shrug off the news and trade as usual.

However, with the release of the European Central Bank (ECB) account of the monetary policy meeting minutes, the EUR gains are expected to be retraced.

US and EUR Policy Divergence to Provide Another Sharp Hit To The Pair

Up until now, the FOMC and ECB have been on divergent policy paths even though the FOMC was not an active participant.

This divergence will likely become more pronounced if the FOMC raises interest rates and tightens its monetary policy in December, as is highly expected, and the ECB expands its quantitative easing (QE) measures.

And according to ECB October accounts, this is very likely.

Meeting minutes show expansion of monetary stimulus was squarely on the agenda. Officials debated whether to further its quantitative easing measures but held off a final decision until December.

More noteworthy is the bank’s tone on current economic woes. It appears bank officials are very concerned about the eurozone’s persistent low inflation figures.

The ECB’s inflation target is 2% but presently, annual inflation is 0.1% stubbornly remaining below its incremental target levels.

Also worrisome was the potent impact of emerging markets and China’s negative influence on the eurozone’s economy.

From the ECB accounts: “It was argued that in such an environment, the risk of deflation remained relevant.

“Against this background, the view was put forward that a case could be made for considering reinforcing the ECB's accommodative monetary policy stance already at the current meeting and, in any case, to act sooner rather than later”

Not everyone agreed. There were opposing views. A few bank officials argued that more economic analysis was needed before a final decision, and that there are signs to show increased and strengthening domestic demand.

The opinions on a rate decrease are more mixed than that of the direction of its QE programme.

Bank officials’ earlier vow to keep rates unchanged is wavering. Some are for a rate decrease but others are not sure, arguing “that a rate cut would venture further into unchartered territory and have repercussions on the functioning of markets and the behaviour of banks and customers.”

So while it is clear that bank officials are of the general consensus that actions need to be taken in the short-term to aid the eurozone economy, the preference of policy direction seems undecided.