EUR/USD Could See New Highs as Dollar "Regime Change Underway" - Strategist

The 1.2670 level marks a 50% reversion of the April 2011 to January 2017 downward trend in the EUR/USD rate, which makes it a significant psychological threshold for the currency market.

The Euro-to-Dollar exchange rate is on course for a collision with a major trend line and a new three year high, according to strategists, who flag the common currency as one of the most likely beneficiaries of a continued rout in the US Dollar.

America’s greenback has been in renewed retreat from its developed market rivals this last week, continuing to wilt against the G10 basket, even as US treasury yields chase after what are close to five year highs.

“The EUR looks to be well-placed to benefit from the loss of confidence in the dollar. Only the EUR and JPY offer the liquidity to make them serious alternative investment destinations for both public and private investors,” says Chris Turner, head of FX strategy at ING Group.

“No doubt we have not heard the last of ECB criticism of US weak dollar rhetoric – an issue that may again re-appear at the G20 in mid-March.”

Not so long ago a rise in US bond yields, over and above those of international rivals, was enough to draw a steady bid for the Dollar from the foreign exchange market.

That has changed over the last four months, to the consternation of many, with US two year bonds now offering their highest yield premium relative to their German rivals than at any other time in recent history while the Dollar continues to fall.

This prompted a robust debate among analysts, economists and strategists over what is driving the decline and how long it might go on for.

As a result, the US Dollar index has gone on to record a near 4% decline barely seven weeks into the New Year, which comes on the back of 10% decline in 2017. These moves have helped the Euro-to-Dollar rate rise by more than 16% on a 12 month time horizon.

“While US authorities may pay lip-service to a stronger dollar, we all know that America First equates to a weak dollar policy. In any case the EUR TWI strength has not been too abrupt. We suspect EUR/USD near term wants to test a big trendline at 1.2670,” says Turner.

The 1.2670 level marks a 50% reversion of the April 2011 to January 2017 downward trend in the EUR/USD rate, which makes it a significant psychological level for the foreign exchange market.

A test of this threshold would put the Euro-to-Dollar rate at its highest point since October 2014, although the exchange rate fell 0.39% to 1.2454 on Friday. 

“There are early signs that the dollar is undergoing a significant regime change – particularly in the nature of the dollar’s decline,” Turner adds.

One of the more common explanations of the US Dollar’s decline during 2017 is that a sudden pickup in the global economy meant other investment destinations had become relatively more attractive when compared with the US from a currency perspective.

After all, the Federal Reserve is already two and a bit years into an interest rate hiking cycles and there are limits to how high interest rates can sustainably go for any country.

This means there is a much lesser degree of upside to American interest rates than there is for other countries and currencies whose central banks still have their own rates down at historic lows.

The same concept applies for economic growth elsewhere in the world given the later stage of the US economic cycle relative to what exists on the continent of Europe, and elsewhere, suggest there is also more upside to growth in the wider world.

“If the 10% fall in the trade weighted dollar in 2017 was a ‘benign decline’ driven by the re-rating stories of overseas economies, then this year’s 4% dollar drop looks far more self-inflicted,” says Turner, in a note Friday.

President Donald Trump’s fiscal stimulus for the US economy has led to a spike in the number of investors who are concerned about a sudden rise of inflation so far in 2018.

This stimulus includes a $1.5 trillion round of tax cuts, an infrastructure plan that has been hawked as $1 trillion or more boost to investment over the next decade, as well as a sharp increase higher Federal government spending in the short term.

Turner and the ING team say these inflation concerns could explain why the US Dollar is no longer following bond yields higher, because the additional yield is required to compensate for inflation.

Moreover, concerns over the likely increase in US government debt that would be required to finance this spending over the coming decades may explain the rest of the greenback’s weakness.

“We’re still very early in this story, but we suspect we are starting to see a fiscal risk premium priced into the dollar – explaining this year’s correlation breakdown.”

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