EUR: The big madness - ING

It cannot be described other than the “EUR madness” according to Petr Krpata, Research Analyst at ING as they see the latest EUR/USD move above the 1.15 level as unjustified by short-term fundamentals (ING estimates the EUR/USD is currently trading with a staggering 2.5% premium vs its short-term fair value).

Key Quotes

“Rather, the EUR rally seems to be about sentiment, technicals and low summer liquidity – factors that are not sustainable for long. Yet, given that this is the name of the game for now, we look for an overshot to/above the EUR/USD 1.20 level.” 

“Indeed, the sentiment towards the EUR/USD changed so much over past months that it won’t take much to break the psychological 1.20 level (even if bund yields are stable). The run-up to President’s Draghi Jackson Hole speech (end-Aug), speculations about the ECB meetings in Sep and Oct and risks of softer US data provide potential catalysts.”

“After a big rally, there will be a pause for a breath 

Yet, the EUR/USD 1.20 level is unlikely to be sustainable for the time being. We look for EUR/USD to return close to 1.15 by end-2017/early-2018 and stay there in 1Q18 due to:

1. The recent EUR strength is unlikely to be welcomed by the ECB. We therefore expect the ECB to deliver more dovish form of QE tapering vs market expectations to tame the currency upside.

2. We expect the run-up to the Italian Parliamentary elections (likely to be held at the end of 1Q18) to take the wind of the EUR sails primarily via the lower bund yields channel. Moreover, with EUR being no longer heavily undervalued and the speculative community no longer being decisively short EUR, the odds of some modest risk premia built-up into the common currency have risen. 

3. On a short-term basis, EUR/USD is already rich (as per above), materially overshooting its short-term financial fair value. If (a) the upside to bund yields is to be limited due to the ECB delivering a dovish form of QE tapering; (b) bund yields decline by the year end/beginning of 2018 due to the Italian election uncertainty, then it will be difficult for EUR/USD to continue pushing higher and the cross should eventually correct to the fairer/more sustainable levels.

4. Plenty of bad news seems to be already priced into USD, in turn limiting the dollar-weakness-led EUR/USD upside. Due to faltering US inflation dynamics, the market all but ignores the Fed’s interest rate guidance, only pricing one and-half rate hikes by end-2018 vs 4 hikes. This limits scope for an additional USD weakness via the Fed re-pricing channel.”