US dollar divides currency analysts

By:
Farah Khalique
Published on:

2014 was hailed as the year of the dollar comeback by analysts across the Street, but the prediction has fallen flat as the US currency has failed to strengthen against the euro. Forecasters are divided as to what the future holds for the world’s most traded currency pair.

Euro-dollar is trading at around 1.37, the same as at the start of the year, confounding currency analysts. The dollar even, at times, lost ground against the euro, with euro-dollar trading up to 1.39 at the beginning of March.

"It has been interesting because as a marketplace of forecasters, we have almost all been very bearish the euro and bullish the US dollar," says Camilla Sutton, chief currency strategist at Scotiabank. "Short-term traders have become very frustrated from shorting the euro."

The US experienced an unexpected weak first quarter, which analysts partly blamed on the polar vortex weather crisis.

On the other hand, steady economic progress in Europe and strong capital inflow into the continent has boded well for the euro, helping keep euro-dollar on an even keel. Last week, the European Commission (EC) published an influential report that predicted growth in the euro area will reach 1.2% this year, up from a fall of 0.4% last year.

Siim Kallas, vice-president of the EC, says "the recovery has now taken hold" and predicted growth across the European Union, going into 2015.

The UK and the eurozone have delivered "better than expected" numbers this year, which explains why the market got the dollar bull story wrong, says Daragh Maher, FX strategist at HSBC.

Keep the faith

Currency analysts are now divided. Some remain confident the dollar will stage a comeback later this year. JPMorgan is one such bank whose forecasts for euro-dollar remain unchanged – 1.36 for the end of the second quarter and 1.30 for the end of the year.

The bank anticipates the possibility that the European Central Bank (ECB) will announce a number of steps in its June meeting, such as a rate cut and a negative deposit rate, to stimulate the economy, according to a research note published on Monday.

"Over the medium term, however, the underlying forecast driver is an assumption that US rates and FX market volatility are at unsustainable levels relative to the US wage/inflation risks likely to emerge later this year," the report states.

JPMorgan even predicts the euro could weaken to 1.25 if the ECB embarks on quantitative-easing measures, such as a €1 trillion asset-purchase programme.

HSBC also believes the dollar with strengthen as the year continues, predicting euro-dollar to sink to 1.28 by year-end. The current focus is on the euro and ECB action, but soon the debate will move on to Federal Reserve action and potential interest-rate hikes, says HSBC’s Maher.

However, UniCredit Bank is a notable outlier. The European bank is mightily bearish on the dollar versus the euro, predicting euro-dollar to rise to 1.45 by the end of the year.

Vasileios Gkionakis, global head of FX strategy at the bank, says the eurozone is in the process of "normalization", as peripheral spreads tighten.

He pointed to the record current-account surplus in the eurozone, which amounts to 3% of GDP, and the improved current-account surpluses of peripheral countries such as Greece, Italy and Ireland.

"Exports are picking up quite considerably across periphery of eurozone, [and there is a] better external balance, which shows sufficient demand for euros to support the current price action," says Gkionakis.

He predicts that, as a longer-term trend, central banks and reserve managers will diversify into euros, as faith in the single currency has been restored. This demand will add support to the currency.

Data from the IMF shows the number of euros in official foreign-exchange reserves for the last quarter of 2013 increased to $1.5 trillion, while US reserves fell slightly to just over $3.8 trillion.

Currency composition table  Source: IMF


Furthermore, he believes European equities have "massively underperformed" versus US equities, which in time will attract an inflow of money into euro assets.

Recommended trades for those that remain bullish on the dollar include shorting the euro and yen, says Scotiabank’s Sutton. UniCredit’s Gkionakis recommends investors go long the euro and UK sterling, in anticipation of these currencies potentially strengthening versus the dollar.

"We definitely like cable [dollar/sterling] for the upside," says Gkionakis.

Data surprises table