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Foreign Exchange

EURUSD at $1.62 without debt crisis; single currency already weak

For those asking why EURUSD is not trading below $1.20, RBC Capital Markets has an answer.

Elsa Lignos, strategist at RBC, has been busy debunking what she calls the myths of G10 FX and believes the conventional wisdom that EURUSD should be weaker is one of them. “One of the most frequently asked G10 FX questions right now is, why isn’t EURUSD weaker?” she says.

“With everything that the eurozone debt crisis has thrown its way, why isn’t EURUSD trading below $1.20 or making new multi-year lows?”

However, Lignos points out the EUR was the worst-performing G10 currency last year and is historically weak against all currencies except USD.

So, she asked the counterfactual question: where would EURUSD be trading if it was not for the debt crisis?

To estimate that, RBC constructed a synthetic EURUSD, mimicking how the currency pair used to trade before the crisis.

 EURUSD could have reached $1.74 without debt crisis

 
 Source: RBC, Bloomberg

That synthetic EURUSD, which has been as high as $1.74, is now at $1.62, putting RBC’s estimate of the negative periphery risk premium carried by EUR at 31 cents.

“This was our reasoning for calling EURUSD higher in the first quarter – there was a lot of bad news already in the price,” says Lignos.

She still sees plenty of scope for negative news from the eurozone periphery, and from parts of the core, but the hurdle for EUR weakness is high because the currency is already weak.

“We expect EURUSD to end 2012 above the year-to-date lows,” says Lignos.

RBC has a forecast of $1.27 for EURUSD at the end of the fourth quarter.

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