Euro, Yen to Fall v US Dollar this Week say Barclays Strategists

Barclays have written to clients telling them they are anticipating a decline in the EUR/USD exchange rate over the duration of the week commencing February 27.

In a note dated February 26, a group of strategists at the London-based bank say their trade for the week is:

“Long USD vs. EUR and JPY going into this week given that EUR and JPY are the two most sensitive currencies to both the level of and any changes in short-term yield differentials vs. USD.”

Justifying the pro-USD stance the team say they expect the USD to remain supported this week as near-term US Federal Reserve hike pricing could rise further.

Also, “President Trump’s speech to the joint session of Congress on 28 February will be keenly watched, but it remains to be seen how much new detail on his key policy agenda, such as tax reforms, will be revealed.”

If the Trump administration continues its discreet approach to its protectionist agenda Barclays reckon the US Federal Reserve could actually hike in the first half of the year.

“Against this backdrop, the market pricing of a near-term Fed hike appears too low and we expect the market to price in greater likelihood of near-term hikes. Yellen and Fischer at their speeches this Friday could jawbone market in that direction and further acceleration in the core PCE deflator should help reinforce those dynamics,” say Barclays.

Meanwhile, there is concern the US Dollar is overvalued but it is argued this overvaluation can persist with the economy’s cyclical outperformance.

“Relative US economic outperformance and solid data are likely to support the USD strength despite its overvaluation,” say Barclays.

The suggestion that the US Dollar is overvalued is echoed with analysts at SEB Markets - the Scandanavian financial services provider.

SEB's Richard Falkenhall recently told his clients that his bank's Long-Term Fair Value (LTFV) estimates show that in trade weighted terms the USD is presently one of the most overvalued G10 currencies, surpassed only by its smaller commodity related counterparts.

Except for the GBP, which is 25% undervalued against the Dollar, most other G10 currencies, however, trade well inside their historical ranges compared to their LTFV.

"For example, the Euro and Yen are approximately 10% undervalued against the greenback. In the longer term it is reasonable to expect the dollar to correct lower against most currencies,” says Falkenhall.

Generally currencies tend to deviate more or less from their LTFVs. These deviations may be sustained for fairly long periods due to one or more factors. However, in most cases SEB say deviations of 20% or 30% indicate an unsustainable stretch, when it would be reasonable to expect the exchange rate eventually to experience a more substantial correction towards its equilibrium level.

Beware Month-End

However, we would point out that there is a potential roadblock in the way of this EUR/USD call in that this week also sees the turning of the month.

With month-end comes investor rebalancing - a process whereby currency adjustments are made by global fund managers based on the performance of stock markets.

Because US stocks are higher this month analysts believe the US Dollar will be sold as global investors rebalance.

But RBC Capital note the US Dollar is likely to underperform currencies other than the Euro:

"US equities are up 3.9% MTD, sufficient to trigger USD selling signals against GBP, AUD, CAD, and NOK from our month-end hedging model,” says RBC Capital's Adam Cole adding this is, “sufficient to trigger comprehensive USD selling signals from our month-end model.”