ANZ FX Strategy: EUR/USD Forecast Targets on Potential range Break

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A key question for currency managers is: where do the risks to a breakout from established trading ranges in the euro to dollar exchange rate lie? Brian Martin at ANZ FX Strategy writes:

For markets, the perceived lower boundary of negative policy rates (ECB), maxed out fiscal policy, and the asymmetric risks facing the FOMC have fostered expectations of ‘policy inactivity’.

The EUR/USD has reflected that by being similarly ‘inactive’.

So a key question for currency managers is: where do the risks to a breakout from established trading ranges lie?

Owing to the advanced stage of the US business cycle and perkier core inflation data there in recent months, we continue to see a greater risk of a repricing for higher interest rates in the US than in the euro area.

While the euro has benefitted from guidance that the ECB is, to all intents and purposes, at the limits for negative interest rates, it has failed to break through 1.15, and the ECB has no intention of raising interest rates on a short- to medium-term horizon.

By contrast, we have long been of the view that the FOMC wants to raise interest rates and normalise policy.

It just has to do so carefully. Instilling the concept of ‘gradual’ in market psychology has been important in puncturing the early Q1 spike in volatility this year.

It has also been important in helping to stabilise the reaction function of other central banks (ie the PBoC).

However, gradual means ‘gradual’ and it still does signal an intention on behalf of the FOMC to raise interest rates

So, unless one is of the conviction that the US is headed back into recession or that some exogenous disinflationary shock is about to hit the US economy, then the risk to the US interest rate outlook is either that expectations stay where they are, or that they reprice for higher policy rates.

In short, therefore, the current period of stability in EUR/USD may prevail for a while longer.

But unless we are wrong on the US economy, we do not see the fundamental conditions for a stronger EUR being in place just now and feel that an anticipated improvement in US data during Q2 should bolster the USD’s fortunes.

ANZ targets EUR/USD at 1.10, 1.07, and 1.08 by the end of Q2, Q3, and Q4 respectively.