Euro-Dollar Weakness Ahead as "Stars Aligning for USD Rebound"

Image © Adobe Images

Amidst U.S. political intrigue, Danske Bank says the stars are aligning for a U.S. Dollar rebound that would push the Euro to Dollar exchange rate below 1.05.

The Euro to Dollar exchange rate has recovered to 1.0853 over recent weeks as the Dollar enters a summer lull, but Danske Bank analyst Antti Ilvonen says several themes point to a U.S. dollar comeback.

"Looking 1-3 months ahead, we see several potential themes that could drive shakier risk sentiment and further USD strengthening ahead," says Ilvonen.

Danske's end-2024 forecast is well below the median forecast of over 30 investment bankers and comes amidst a period of USD weakness, which left the broader USD index 1.30% lower in July and the Euro-Dollar higher.

Currency markets have shown little reaction to news President Joe Biden is withdrawing from the November election and that Vice President Kamala Harris will replace him on the ballot.

Indeed, Danske Bank thinks U.S. fiscal policy stance is likely to remain supportive for growth irrespective of the election result, even if policy focus areas could change, which could also help explain the rather muted market reaction to the announcement.

A key lynchpin of U.S. Dollar outperformance in the first half of 2024 was the undoubted supremacy of U.S. economic growth relative to other G10 economies. If this can continue, so too can USD outperformance.

"The US economy is cooling but not collapsing. Weaker signals in some leading indicators are balanced by still supportive fiscal policy, low number of layoffs and strong consumer spending, meaning that the Fed is likely to opt for a more gradual pace of cuts than markets are currently pricing," says Ilvonen.

Meanwhile, the Fed is expected to cut interest rates twice this year and four times in 2025.

Regarding the election, Danske Bank thinks a "tightening race could tamper markets’ hopes for looser tax policies."

This could contribute to a deterioration in risk sentiment, which can boost the Dollar.

An important consideraiton is the Federal Reserve's quantitative tightening programme, which will drain more liquidity from the U.S. banking system. This "leaves market sentiment more vulnerable for setbacks."

Given the above, Danske forecasts Euro-Dollar at 1.07 in three months and 1.03 in twelve months.