Euro-to-Dollar Rate Eyes Trend Reversal as Economic Surprise Indices Converge

-EUR/USD boosted by Trump's attack on Federal Reserve.

-Can go further now US-EU economic surprises are in balance. 

-But lasting recovery will need time, likely until 2019, to take hold.

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The EUR/USD rate rose Tuesday as the Dollar wilted broadly in response to President Donald Trump's attack on the Federal Reserve, but analysts say it could go further during coming months now that Transatlantic economic momentum is coming back into balance after months of US outperformance.

Economic surprise indices for the Euro area and US economy are converging once again, albeit because of a series of recent disappointments in US data and not upside surprises in anything emerging from Europe. While not enough to have analysts rushing out to buy the Euro just yet, it does remove some of the earlier incentive to sell it and buy the Dollar instead.

"There has been some convergence in the economic surprise indicators of the US and the Eurozone which could be EUR/USD supportive. And a break of 1.1530 could carry EUR/USD to 1.1600 in thin markets – but as noted above a sustained turn-around in the bear trend probably requires a less hawkish Fed or a surprisingly upbeat ECB - neither of which seems imminent," says Chris Turner, global head of FX strategy at ING Group.

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

Most analysts now agree that superior US economic growth so far in 2018 has enabled the Fed to go on raising its interest rate at a time when slowing growth has led to a deterioration in the Eurozone monetary policy outlook.

The pace of quarterly GDP growth slowed to 0.4% in the Eurozone during the first quarter, down from 0.7% previously, and held this pace during the three months to the end of June. US economic growth reached its fastest quarterly pace for four years during the second quarter.

The European Central Bank said in June it will not contemplate an initial interest rate rise until after the summer of 2019 when markets had been hoping it would make a move around June next year. Meanwhile, the Federal Reserve has already raised its interest rate two times in 2018. 

The Fed has raised interest rates seven times since the end of 2015, including twice in 2018, taking the Fed Funds rate range to between 1.75% and 2%. Many economists expect it to raise rates so the top end of that range hits 3.25% around the end of 2019.

"EUR/USD [could] break back above 1.16 now that positioning data suits our long-term bias but really, President Trump jaw-boning isn't a sensible reason for it to happen. A shift in the EU/US relative economic surprise indices is a better reason, and there are signs that's happening, but at the risk of sounding like a very broken record, higher Bund yields are a precondition for euro strength because they would be a clear sign that markets are beginning to believe in ECB normalisation again," says Kit Juckes, chief FX strategist at Societe Generale. 

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

The growth and interest rate mismatch created an incentive for traders to sell the Euro and buy the US Dollar during the second quarter, leading to an 8% decline in the Euro-to-Dollar exchange rate that has now left it sat on a 4% 2018 loss. 

However, after PMI surveys of the US manufacturing and services sectors both falling much faster than was expected for the month of July, momentum now appears to be ebbing from the US economy. This is because, unlike data measuring things like retail or overall economic output, PMI surveys also attempt to gauge the likely pace of future activity. 

Survey respondents are asked to score the outlook for their company around a range of issues and responses are condensed into an index that is represented by a single number. It is these indices that have surprised on the downside of late and are now in outright decline. 

Analysts, economists and strategists are floating the possibility of this heralding an eventual reversal in the Euro-to-Dollar rate trend, although some positive news from Europe would likely be required first before the market is willing to get fully behind the single currency once again. 

"In the short-term, EURUSD risks are still to the downside," says Athanasios Vamvakidis, head of European G10 foreign exchange strategy at Bank of America Merrill Lynch. "However, we will be looking for an opportunity this fall to go long the Euro ahead of next year, when we forecast EURUSD at 1.20...Stay tuned for now and get ready for the right time to buy the EURUSD dip."

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

For the time being, September will see headlines dominated Italy and a looming showdown between the Mediterranean nation's new coalition government and EU fiscal hawks in Brussels.

This could unsettle markets because both coalition partners are long-term Eurosceptics so fears are that a clash with Brussels over Italy's continued breach of Eurozone budget rules would stoke the government's hostility toward the single currency and European Central Bank.

It could also ferment anti-Euro sentiments within the broader Italian population, reigniting concerns over whether the Eurozone will be able to survive the coming years without losing any of its members. 

"We expect the ECB to start hiking next year—before or after the summer does not really matter. Draghi will be replaced, most likely by someone less dovish. The impact of the US fiscal stimulus will gradually weaken. The Euro has the tendency to appreciate if there is no new news, given the large Eurozone current account [surplus] and ongoing reserve diversification away from the USD," says Vamvakidis. "Our equilibrium EURUSD estimate is 1.22."

The Euro-to-Dollar rate was quoted 0.26% higher at 1.1522 during the noon session Tuesday.

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