Citi on Why the Euro / US Dollar Exchange Rate is Losing Momentum

The euro to dollar exchange rate remains biased higher in our view but there is also a good body of evidence to suggest the prospects of further advances are limited.

We have written recently that the euro is looking to make a notable break higher against the US dollar and move above its long-term range between 1.05 and 1.14.

Our call is based on the observation of the exchange rate's weekly charts which implies that this is a multi-month view, so we are not too concerned by any declines in the near-term.

Indeed, the declines we have seen in EUR/USD of late are justified argue analysts at Citigroup who believe the euro is looking expensive after its recent February-April push higher.

Citi argue fundamentals are likely to re-assert their impact on FX and this will likely favour the United States which continues to grow at a faster rate than ite Eurozone counterpart thanks to a burgeoning labour market. 

It is also argued that the US dollar just won't be able to fall much further as US interest rate markets, and by implication the USD, are already pricing in a very small chance that the Federal Reserve will raise interest rates this year.

Money markets are ascribing a mere 50% chance of one 25bp hike this year.

The fuel to the dollar rally of recent years has been the promise of higher interest rates and when the fuel supply is squeezed the dollar naturally falls back. Citi suggest money markets will struggle to cut probabilities yet lower than they already have which should provide a modicum of support to the currency.

“USD bears are going to find it difficult to even reach last year’s lows let alone slide beyond that,” argue Citi.

The USD Index, a measure of the dollar's overall strength, hit a low of 91.08 in 2015, some 3.5 big figures below current levels. It is suggested that the key factors driving the dollar lower (seasonality plus Yellen) are starting to fade.

“At the same time, the medium to longer term fundamentals on EUR and some other G10 FX remain bearish and current longs are likely to re-asses their overall trade should EURUSD (for instance) trade past the 1.1450 level,” say Citi.

In addition Citi note weaker EUR fundamentals should now likely re-assert themselves with ECB purchases of debt under its QE program set to kick start at the beginning of the new month.

This should result in a roughly 33% increase over existing flows making Citi, “EUR bearish once past the US jobs report.”

The combined monthly purchases under the ECB’s Asset Purchase Programme (APP, loosely referred to as the QE programme) are to increase as of 1 April 2016 to €80 billion from €60 billion.

Investment-grade euro-denominated bonds issued by non-bank corporations established in the euro area will be included in the list of assets eligible for regular purchases under a new corporate sector purchase programme (CSPP).

The CSPP will be added to the APP and will be included in the combined monthly purchases.

Commerzbank, Intesa Sanpaolo: EUR/USD Losing Momentum

The pace of the euro’s tear higher is also of concern for those looking to bet on further climbs as the pair is left looking rather overbought.

“EUR/USD’s high on Friday at 1.1438, was not confirmed by the daily RSI and this suggests a loss of upside momentum just ahead of the September and October highs at 1.1460/95 and the 1.1577 pivot line,” says Karen Jones, a technical analyst with Commerzbank in London.

Jones considers this line as, “the last defence for the 1.1713 September high,” which would be seen as the next target for the move higher.

Nearby support is offered by the accelerated uptrend at 1.1276, this guards the 1.1144 24th March low.

Key nearby support lies the 1.1060/58 December high and the March 16 low. This guards the bottom of the range at 1.0808.

The baseline scenario held at Italian lender Intesa Sanpaolo is still a weakening of the exchange rate towards EUR/USD 1.10 on a 1m horizon.

"Although a return to that level may prove neither smooth nor immediate. In the euro area, an important event this week will be Draghi’s speech on Thursday," says Intesa Sanpaolo's Asmara Jamaleh, "the event which may have the strongest downside impact will probably be Draghi’s speech on Thursday."

Following the ECB meeting of 10 March, the euro had appreciated, mostly because Draghi’s statements had let on that the interest rate cut in March may have been the last.

"Any doubts on this latter point would aid the retreat of the euro," suggests Jamaleh.

DNB Markets Cut Euro to Dollar Exchange Rate Forecasts

Analysts at DNB Markets have meanwhile revised down our expectations for Fed, seeing only two hikes this year, 4 in 2017 and one in 2018.

This sees them make a corresponding revision to theirr forecast for EURUSD.

Analysts forecast for 1, 3 and 12 months are 1.12, 1.10 and 1.04, respectively.

"Diverging monetary policy will continue to favour the USD. We see a next Fed hike in June and another hike before year end. More aggressive hikes in 2017. The ECB is on the other hand expected to continue the expansive monetary stance for very long," say DNB.

Despite the anaemic recovery in the Eurozone DNB say the risk of an unfavourable outcome will gradually be reduced.

Eurozone current account surpluses and central bank demand for EUR should result in a stronger EUR going forward argue DNB.