Revised forecast-2015: EUR/USD

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Last time I revised my annual forecast for the euro/dollar pair in early May. Now, it’s time to make some adjustments to it.

The main hypothesis of the May forecast was the Euro’s decline to $ 1.04 on the back of the Federal reserve’s monetary policy tightening. So, my expectations were based on fundamental analysis. In one of my May articles I even said that from a technical point of view, another hypothesis seems more attractive – the beginning of a long-term “bullish” trend it the EUR/USD pair after March decline to the lower border of its long-term downtrend channel (see Chart 1).

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Today, looking at this Chart, I ask myself a question: maybe I should’ve trusted the “technicals” more? The European currency is far gone from the March lows and has already reached its highest levels since January. Maybe the “Eurobulls” have already won this battle, and the EUR/USD will keep climbing higher and higher until the end of the year…

There seem to be fundamental reasons for the positive prospects of the Euro too. According to preliminary Markit Economics data, the Eurozone’s composite PMI rose from 53.9 to 54.1 pips in August. Thus, the index is back above the previous year high(54 points), which it first registered in June, rising to 54.2 (see Chart 2).

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Based on these data, a senior economist at Markit Economics Rob Dobson even said that the Eurozone’s economy was going through “one of the best periods in the past four years.” And some analysts have suggested that this PMI dynamics indicates accelerated GDP growth in the third quarter from 0.3% to 0.4% q/q.

In the light of such positive prospects, the Euro’s growth against the dollar may seem quite logical, especially considering that expectations for a September rate hike in the United States have recently decreased, hampering further strengthening of the US dollar against its major competitors.

But let’s not jump to conclusions. A detailed analysis of the situation shows that the euro’s growth on the back of the global stock markets collapse and falling commodity prices was triggered not by a sudden wave of optimism about the eurozone’s economy, but by the same reason as the Japanese yen’s growth – increased demand for funding currencies.

Since the ECB lowered its key interest rate to 0.05% nearly a year ago, in September 2014, loans in Euro began to play the same role as the loans in yen – they have become a very convenient (in other words – cheap) instrument for transactions in the financial markets. During the past year, investors actively used borrowed funds in euros for investments in various assets of the stock market: they bought stocks, bonds, commodity futures. When the stock market collapsed, there was a massive switch out of stock markets into cash among investors. Demand for the Euro, as well as the yen, soared. As a result, the euro and the yen strengthened sharply against the US dollar on Monday. And yesterday, when stocks partially recovered, both funding currencies simultaneously declined.

Understanding the nature of the Euro’s recent strengthening makes me very cautiously consider further possible EUR/USD strengthening.

  • First, the resources for the Euro’s growth due to the closure of open positions on borrowed funds are limited by the amount of these loans. In addition, it is clear that such growth is possible only in case of continuing sales in the stock and commodity markets.
  • Second, we should understand, that positive shifts in the euro-zone’s economy, indicated by the business activity indices (PMI’s), became possible mostly due to a significant weakening of the euro, that has occurred over the last year. And if now, when one country after another devalues its currency to support domestic producers, the euro zone’s currency suddenly begins to strengthen, we’ll have to forget about the GDP growth acceleration in the region, as well as about the acceleration of inflation. There is no doubt that the ECB is well aware of this fact and will do everything possible to curb further Euro’s strengthening.

Therefore, in case of continuing sales in the world’s stock exchanges I admit the possibility of the EUR/USD growth, but only to its 2010 lows around $ 1.1875 (or the lows in 2012 near $ 1.2050s if the collapse turns out to be very strong and the Fed even refuses to increase rates this year). However, “admitting” does not mean “expecting.” If markets stabilize, then the euro won’t probably set new records this year, thus it shouldn’t growth above the $ 1.17 mark.

As for decline of the single currency, I still expect it. The scale will depend on the degree of Fed’s “hawkishness”. If, in spite of that, the Fed increases its rates twice before the end of year (in September and December) by 25 basis points each, the euro may reach the level of $ 1.04 at the beginning of 2016. If the Federal Reserve ventures just for one rate hike, I’ll be expecting the euro to fall into the range of ​​$ 1.07-1.08 in the fourth quarter.

 

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About Author

I have been friend with currency market since 2006. I hope that this friendship is not only useful to me, because over the years I have repeatedly provided analytical services to various companies and media outlets. I love fundamental analysis. Every day, I am convinced that the statistics is not boring numbers but fascinating reading, which, moreover, can predict the future. Technical analysis is also not neglected, especially as my hobby - finding effective algorithms for automated trading systems.