Julius Baer: Euro / Dollar Rate to end the Year at 1.12, 'ECB Trade' Run too Far

The forecast for a lower EUR/USD by the end of 2017 sets Meier and his team as outliers in the forecasting community, but their message is credible - this ECB trade is burning hot.

The Euro to Dollar exchange rate has cracked through the ceiling at 1.20 in late August seemingly without any resistance which would typically be expected of such psychologically significant levels.

The move higher servers to illustrate how dominant the Euro’s uptrend is at the present time and calling a top in the market under such conditions is fraught with difficulty.

As such, we expect forecasts for EUR/USD roll over yet again as analysts play catch-up with the market.

“With the chances of another Fed rate hike this year having dropped to around one third and Mr. Draghi not making any reference to the Euro’s appreciation at the Fed symposium, risks to our current EUR/USD forecast of 1.20 for end-2017 have thus become even more tilted to the upside,” says Marco Valli with UniCredit Bank in Milan.

However, there are some analysts unwilling to be washed away by the Euro’s tide; according to David A. Meier, Economist, with Julius Baer in Switzerland the Euro will turn notably lower.  

This ECB Trade has its Limits

The Euro’s most recent bout of strength was triggered by following speeches delivered by European Central Bank President Mario Draghi and Federal Reserve Chair Janet Yellen at the Economic Symposium held in Jackson Hole, Wyoming ahead of the weekend.

“The explanation is simple: Draghi offered some information, Yellen none. Although Draghi’s luncheon address did not cause the sandwiches to stick in his listeners’ throats, he did confirm that there will eventually be an end to the ECB’s asset purchase programme,” says Meier.

It is the expectation that the ECB will end its quantitative easing programme that has prompted the foreign exchange community to bid the Euro higher through the course of 2017.

Draghi stressed nevertheless that the normalisation of the ECB’s expansive monetary policy will be very slow due to lagging inflation.

Furthermore, he did not voice any concerns about the currently strong Euro levels.

“This was the key item that markets jumped upon, as they now do not expect Euro strength to hinder the ECB in policy normalisation, ignoring the warnings that it will be a slow process,” says Meier.

EUR/USD is less than halfway between its 2008 1.6038 high and last year's 1.0352 low. 

The 5-year average value of EUR/USD is around 1.21 and "that may explain why the ECB is not overly concerned about the euro's level," says Kathy Lien, Director at BK Asset Management in New York.

Meier is however concerned that markets are getting ahead of themselves when it comes to this ‘ECB trade’.

“We continue to believe that current Euro strength expresses exaggerated speculation on ECB monetary policy normalisation, while we still expect a Fed rate hike in December, based on cyclical strength and a recovery in inflation ahead. Euro euphoria should ebb off while higher rates support the dollar, explaining our EUR/USD three-month forecast of 1.12,” says Meier.

This sets Meier and his team as outliers in the forecasting community but the message is credible - this trade is burning hot.