Euro-to-Dollar Rate Forecasts Downgraded Again as Strategists Eye New Lows

-EURUSD headed to new lows this summer say BofAML. 

-Strong USD and jitters over Italian budget to drive sell-off.

-Chimes with Credit Suisse, Morgan Stanley views on currency.

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The Euro-to-Dollar outlook has darkened in recent weeks, according to the latest forecasts from strategists at Bank of America Merrill Lynch, who are arguing the exchange rate will set new lows this summer and that its subsequent recovery will be shallower than many expect.

This call comes as the Bank of America team forecast a continuation of the US Dollar rally that has dominated currency markets since the middle of April, alongside renewed weakness for the Euro toward the end of summer as the single currency grapples with concerns over Italy's 2019 budget and reduced economic momentum. 

"The quarter is ending with EURUSD weakening to our projection of 1.15, but we see further downside risks this year. The US data is consistently better than the Eurozone data and we expect this to continue for the rest of the year," says John Shin, a G10 FX strategist at Bank of America Merrill Lynch. "Historical correlations with data and rate differentials would be consistent with a much weaker EUR."

In January the US Congress passed one of the largest packages of tax cuts and reforms in US history, slashing corporate taxes by nearly half and handing American households an estimated average of around $1,200 in additional disposable income per year. 

This has buoyed US retail spending and overall economic activity, as well as the Dollar, to an extent where economists are now forecasting US GDP growth to top 4% on an annualised basis in the second-quarter. 

Above: Euro-to-Dollar rate shown at daily intervals.

The Tax Cuts and Jobs Act also offered US companies a one-time tax break on all foreign profits earned after 1986 and created new mechanisms through which US authorities can tax overseas profits regardless of where they are held. There is an estimated $2.7 trillion of profits that have been hoarded overseas during recent decades.

That US upturn comes at a time when economic growth in Europe has ebbed from the high levels seen back in 2017. Eurozone GDP growth slowed by nearly half, to 0.4%, during the first quarter and recent data suggest the continental economy has not fully recovered its mo-jo in the months since. 

"Most of the US profit repatriation we have been expecting following the tax reform is ahead," says Shin. "We are concerned about the Italian budget discussions this fall, given the plans of the new government for substantial fiscal policy loosening."

Eurozone policymakers are grappling with challenges posed by the new Italian government, a coalition whose only unifying quality is a shared sense of Euroscepticism, that was elected on a platform of promises to roll back unpopular post-crisis austerity measures.

EU fiscal laws, some of which were strengthened after the Eurozone debt crisis, have made far-reaching austerity a mandatory menu item for many Southern European countries in recent years. 

They require member states to submit their annual budgets to Brussels for approval, which means they can also be rejected by Brussels if national government proposals breach the European Commission's rules or requirements. 

Fears are the new Italian government's maiden budget is destined to be rejected, which could place Italy and Brussels on a collision course with eachother that serves only to stoke the fires of Euroscepticism in Rome and beyond. This could give way to renewed concerns over a possible Italian exit from the Eurozone. 

The Euro-to-Dollar rate has already turned what was a 4% 2018 gain as recently as the middle of April into a 2.4% loss, in tandem with a similar move in the trade weighted US Dollar, which has converted a 4% 2018 loss into a 2.6% gain. 

"We are therefore updating our projections for Q3 to 1.12 from 1.17, for end-2018 to 1.14 from 1.20, and for end 2019 to 1.20 from 1.25," says Shin, of the Euro-to-Dollar rate. 

These are substantial downgrades from Bank of America's earlier targets, which henvisaged EUR/USD bottoming out at 1.15 around now and rising back to 1.20 before year end. Shin's forecast is for the rate to now fall back to 1.12 before the end of September, which would mark its lowest level since June 2017.

Above: Euro-to-Dollar rate shown at weekly intervals.

Bank of America's view chimes with the broad thrust of sentiments expressed by strategists at Credit Suisse earlier this week, who say clients of the bank should keep selling EUR/USD rallies over the summer months.

"Ongoing sensitivity to politics suggests we should not change our 'sell rallies' EUR/USD view for the summer ahead of the Italian budget focal point that's likely in September. We note that each corrective rally fails at a lower point than the previous one, which adds to the odds that key support at 2018 lows around 1.1500 breaks going forward," says Shahab Jalinoos, head of FX strategy at Credit Suisse.

However, as much as the Bank of America and Credit Suisse teams are bearish in their outlook for the single currency, not all strategists are this downbeat on the single currency. The Morgan Stanley team still see more losses ahead for the Euro but envisage a quicker recovery and are more upbeat about the longer term outlook for the currency too. 

"A key driver of some investors' USD-bullish view is a bearish one on EUR – we suggest that it is too quick to pass judgmenthere. EURUSD is far from fair value (which is likely around 1.30-1.35) and the eurozone's current account surplus of 3.6% of GDP supports this undervaluation claim. Importantly, this is not just a trait shared by one or two euro area member states – nearly all of them have surpluses. This suggests that downside risks to the currency are more limited than in the past," says Hans Redeker, head of G10 FX strategy at Morgan Stanley. 

Redeker and the Morgan Stanley team project the EUR/USD rate will fall to 1.13 before the end of September and that, after that, it will rise gradually back to 1.15 before year end. They look for the currency pair to finish the 2019 year at 1.32.

The Euro-to-Dollar rate was quoted 0.40% higher at 1.1706 during the noon session Thursday and is now down 2.4% for 2018.

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