Euro-Dollar Undergoes "Regime" Change; 1.1600 New Target

The Euro is expected to continue to appreciate versus the Dollar now that political fears about the integrity of the Eurozone have eased, say Deutsche Bank, who have put out a call for EUR/USD to reach as high as 1.1600.

The rise will be helped by the Dollar’s "grind lower" over the summer as it withdraws from the highs of Donald Trump’s manifold fiscal stimulus promises; the main one of which were promises to radically alter the US tax code.

No game-changer has been delivered by Trump on this front and those gains made following his win back in November have ebbed away.

Market data suggests large investors remain underweight EUR/USD indicating there is some slack for more buying, which is likely to be largely responsible for the next step up to their 1.1600 target.

The Euro’s recent sharp rally, following Mario Draghi’s dovish comments at the central banking conference in Sintra, expressed a move into “new territory”, according to Deutsche Bank analyst Robin Winkler.

Currencies have a positive interrelationship with interest rates because when interest rates rise the flow of capital from international investors also increases pushing up demand and therefore the value of the currency.

Analysts use government bond yields as a proxy for interest rate expectations as they move up and down according to whether the central bank is expected to increase rates or not.

Yields rise in response to interest rate expectations in order to recompense bond investors for not staying in cash.

The already intimate relationship between interest rate expectations and the Euro appeared to multiply exponentially after Mario Draghi’s more hawkish hints at Sintra – hawkish means in favour raising interest rates.

As a consequence of the more sensitive relationship between EUR/USD and yield differentials, the pair broke well above what would had previously been expected from valuation models based on yields.

“The breakdown in the traditionally tight correlation with the yield spread signals a rare regime break and the possibility of large flows into the Eurozone that could gather more momentum in coming weeks as medium-term investors still retain large underweight positions in EUR/USD," said Winkler.

Based on the analysis Winkler makes a trade recommendation to buy at 1.1404 with a target at 1.1600 and a stop loss at 1.1295.

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