Currencies | Feb 25 2010
By Chris Shaw
A number of factors have been working in favour of the US dollar, but above all against the euro in recent months. FX specialists at Danske Bank believe there is a case to make that the downtrend for the euro can be sustained.
The first argument is relative economic performance, Danske Bank noting since early December US economic data have generally surprised on the positive side while data out of Europe have generally disappointed. This trend has created a clear divergence in momentum. This leads the bank to suggest the euro's sell-off against the US dollar of late is at least partially structural, so reflecting more than just the impact of the Greek debt crisis.
The second factor reflects upon the first, as the better than expected US economic data have resulted in a re-pricing in money markets as expectations with respect to the outlook for interest rates have changed. In late 2009 Danske Bank notes the market was discounting a high probability of the European Central Bank (ECB) tightening rates before the US Federal Reserve (Fed), but pricing now suggests the market sees the Fed as likely to be the first to move.
This change in view has been supported by the Fed action in lifting the discount rate, Danske Bank seeing this as a sign the excess liquidity pumped into the US financial system during the global financial crisis could be removed earlier than had been expected.
Factoring this in sees Danske Bank taking the view the euro will remain under pressure against the US dollar in the short-term given weak sentiment, the fact Europe's debt issues are as yet unresolved and as the US economy continues to outperform. Its estimate calls for a rate of 1.33 against a current spot rate of a little more than 1.35.
Over the medium to longer-term Danske Bank expects the EUR/USD rate to remain in overvalued territory (its model suggests fair value in purchasing power parity terms is in a range of 1.20-1.30) but it expects some recovery for the euro on a 12-month basis, with a current target of 1.40 in a year's time.
In its view this will reflect a declining euro risk premium in the market and a loss of momentum in US economic outperformance as the European economy eventually improves. As well, Danske Bank suggests a currently crowded short euro bias in the market is likely to limit further downside potential.
Danske Bank's forecasts for the shorter-term are not too far off Citi's revised numbers, the latter now expecting a 2H10 rate for the euro against the US dollar of 1.37, down from 1.60 previously. Citi is less positive on a euro recovery however as its 1H11 forecast for the currency pair is 1.33, down from 1.56 previously, while for the second half of 2011 its forecast is now 1.32 against 1.49 previously.
What could turn Danske Bank more positive with respect to the US dollar in the medium-term is any signs of sustained economic underperformance in the European region or any evidence of some more widespread contagion from the debt problems in Greece.
As well, Danske sees any sign of monetary policy divergence in favour of the US as potentially proving supportive for the greenback, as the present expectation is for both the ECB and Fed to first lift rates in the final quarter of this year.
