Despite agreeing on the likelihood of the European Central Bank (ECB) cutting interest rates further, analysts differ in their expectations for the value of the euro at the end of this turbulent year.
In a research note published at the end of October, George Saravelos, global head of FX research at Deutsche Bank, suggested the key variable for EUR/USD was neither the ECB policy response nor the scale of Covid lockdowns, but rather a stabilization in coronavirus numbers.
“A relative peaking of Covid cases in Europe versus a rise in the US, in addition to rising political risk premium on the back of dysfunctional US politics should be helpful to the euro,” he tells Euromoney.
According to Paul Robson, head of G10 FX strategy EMEA at NatWest Markets, a Brexit deal has potential to support the euro.
We see EUR/USD appreciation in 2021, but the euro to underperform other currencies
Ebrahim Rahbari, Citi
“The sign-off for the European Union recovery fund should also be supportive, as it should reduce the currency’s risk premium,” he adds.
Kamakshya Trivedi, co-head of global foreign exchange, interest rates and emerging markets strategy research at Goldman Sachs, says the bank does not think that lockdowns in the euro area will cause EUR to depreciate outright.
“However, it does mean the euro may underperform other higher beta currencies and likely won’t participate to the same extent in dollar downside,” he says.
Goldman recently removed EUR from its recommended dollar short basket, versus AUD and CAD.
The EU recovery fund remains a tantalizing possibility if it can deliver coordinated European fiscal policy and end the over-reliance on the ECB to support the eurozone economy.
However, it has not yet been a notable factor in the FX market, according to Kit Juckes, chief global foreign exchange strategist at Societe Generale.
Lockdowns
BNY Mellon Markets senior EMEA market strategist Geoff Yu reckons the length of lockdowns in France and Germany will exert the greatest influence on the single currency, although he still suggests it may outperform USD and GBP.
Citi expects EUR/USD to be generally positively correlated with broader risk appetite; even though there is room for some near-term volatility, it thinks that market risk appetite will be positive into year-end.
“Linked to that will be the decisions by investors to position or hedge their FX exposures,” says Ebrahim Rahbari, Citi’s chief G10 currency strategist and global head of FX analysis and content.
“The present set-up of fairly steep US rates encourages more hedging of US fixed income exposures by investors around the world, including in Europe and Japan.”
There seems to be limited merit in going for negative rates at this point
Geoff Yu, BNY Mellon Markets
Citi also expects USD to sell off into late 2020 and 2021 due to expectations of a stronger global recovery, continued US and global policy stimulus, and a search for value and some diversification among investors globally.
“Amid a USD sell-off, the direction of EUR/USD and the trade-weighted EUR is likely to diverge,” adds Rahbari. “We see EUR/USD appreciation in 2021, but the euro to underperform other currencies, notably in emerging markets.”
Risk appetite is likely to remain supported by the rising odds of a US political gridlock scenario, whereby extreme policies – on taxes and trade, for example – are less probable.
Meanwhile, beyond short-term growth risks, a global recovery is still likely to support more cyclical currencies, such as the EUR.
That is the view of Luca Bindelli, head of global fixed income, FX and commodity strategy at Credit Suisse, who suggests the short-term risks to growth posed by partial lockdowns in Europe have arguably been partly priced in and should be temporary in nature, leaving way for a subsequent rebound.
“The ECB will likely expand its policy support via asset purchases and refinancing operations in December, but should refrain from lowering short-term rates,” he says.
In a research note, Deutsche’s Saravelos suggested there was little the ECB could do to force European rates even lower, noting that another 10-basis-point cut to the deposit rate had already been priced in, despite describing it as unlikely.
Our end-year forecast [for EUR/USD] is at 1.18, but we can potentially see 1.25
Kit Juckes, Societe Generale
Yu at BNY Mellon sees the ECB expanding quantitative easing (QE) first.
“But there seems to be limited merit in going for negative rates at this point, especially with banks’ margins already under so much stress,” he adds.
Recent ECB interventions have pointed to the fact that a rate cut would make sense and be efficient only if the impact of the pandemic was expected to last beyond 2022.
“Our base case is that the ECB would opt for a QE expansion and tweaks to the tiering multiplier and targeted longer-term refinancing operation terms rather than cutting rates,” observes NatWest Markets European rates strategist Imogen Bachra.
Trivedi at Goldman says that rate cuts are not aimed at the key issue facing the ECB, which is maintaining supportive sovereign credit conditions.
“We think there is a revealed preference in the fact that no central bank has cut rates into negative territory, or deeper into negative territory, this year, despite the severity of the Covid shock,” he says.
Citi’s Rahbari agrees that there is a high hurdle for further deposit rate cuts.
“Large, unwarranted FX appreciation – in the order of 10% or more – could bring such cuts back to the table, but that’s not in sight for now,” he says.
Outlook
So, where is this likely to leave EUR/USD at the end of 2020? Saravelos, Rahbari and Credit Suisse’s Bindelli reckon 1.20, while Robson at NatWest Markets pitches it at 1.22 – and EUR/GBP at 0.905 – but HSBC is forecasting 1.15.
“We have been more cautious than others about the outlook for the euro and this continues to be the case,” says HSBC FX strategist Paul Mackel.
Trivedi expects the euro to be about flat into year-end, “reflecting an improving global picture and a positive vaccine outlook, but challenging domestic growth because of lockdowns”.
He then suggests it will appreciate next year to 1.25, given its exposure to the global cycle and structural underweight positioning from international investors.
Societe Generale’s Juckes agrees that a combination of optimism about a vaccine – which should support growth expectations in Europe more than the US, given the response of European governments to the crisis – and the dramatic convergence of European and US real interest rates should support a continued recovery by the euro against the dollar.
“Our end-year forecast is at 1.18 and so has already been reached, but we can potentially see 1.25 reached sooner than expected,” he concludes.
