The EUR/USD Rate Debate: Is 2017 Low at 0.95 or 1.03?

The Euro / Dollar exchange rate will be on a recovery path by the end of 2017 we are told by two institutional analysts.

However, there is a notable divergence in opinion when it comes to calling the exchange rate's bottom.

Analysts at Italy's Intesa Sanpaolo have written to clients this week confirming further weakness is likely over the coming three months, but a recovery should ultimately shape up from mid-year onwards.

Intesa’s Chief Economist, Luca Mezzomo, sees that Fed expectations of two or three rate hikes are already priced into the exchange rate and this should ultimately limit the Dollar's downward influence on the pair.

Rate hikes are expected, predominantly, as a result of an increase of economic activity caused by Trump’s reflationary policies.

“The market has by now priced in this scenario, and expects two or three rate increases this year, essentially in line with the three envisaged by the Fed,” said Mezzomo.

Mezzomo now sees a phase starting in which the exchange rate will reflect any “discrepancies between the policies announced and those that will be effectively implemented.”

He says that this new phase of increased uncertainty has led the Fed to adopt a wait-and-see approach once again which is more neutral for the Dollar.

Analysts at Holland's ABN Amro appear to disagree and expect the Federal Reserve to be as aggressive in raising rates as officials indicated in the December meeting.

They also see cyclical factors as supporting Dollar strength and have made buying Dollar's a conviction trade.

“We remain positive on the US dollar (USD) given our view that the Fed is likely to raise interest rates more aggressively (75bps) than what is priced in by financial markets (50bps). In the current environment, the US dollar is driven by cyclical factors and upside in the US dollar goes hand-in-hand with a rise in equities, cyclical bonds, higher official rates, higher US Treasury yields and higher real rates,” said ABN’s FX Strategist Georgette Boele.

Nevertheless, they share the view that future gains will be conditional on the market still believing in Trump’s stimulus promises.

“We expect the US dollar to rise as long as the market perception is alive that the Trump Administration will be positive for US economic growth without too sharp a rise in inflation,” said Boele.

The Euro: Disagreement Over Pricing of Tapering 

Perhaps the greater contrast in views is noted in relation to the outlook for the Euro.

Mezzomo is constructive, arguing the market’s view of the ECB’s ultra-accommodative stance has already “expressed itself” in the exchange rate.

“The downside potential tied to the ECB’s ultra-accommodative conditions is now estimated to have fully expressed itself, therefore it should not single-handedly push the Euro to new lows – and in particular below parity – barring a deterioration of the macro picture of such an extent as to prompt the ECB to further step up monetary stimulus,” says Mezzomo.

However, ABN Amro are betting that the ECB will extend its accomodative conditions and pressure the Euro lower.

Drawing on the ECB’s recent survey of forecasters, ABN Amro’s Boele argues that the survey indicates the ECB’s own forecasts for inflation are overinflated, and there is a high risk of prices undershooting.

Given their monetary policy outlook is modelled on their inflation forecasts this suggests there is a possibility they will be disappointed and decide to increase stimulus to offset the decline in inflation.

This will have the effect of weakening the Euro, which they see falling to 0.95 to the Dollar in H1 2017, before recovering to parity or just above.

This contrasts with Intesa Sanpaolo’s forecast that EUR/USD will be at 1.05 in three months, 1.07 in six months and 1.10 in twelve months.

The lowest point expected is at 1.03 within a month, however judging by the pair's recent performance this is unlikely.