FX | US | Europe
FX Focus - EURUSD: What Does Euro’s Rebound Tell Us?
Posted on| Forecast | Spot | 0 - 3m | 6 - 12m | Long-term |
|---|---|---|---|---|
| EURUSD | 1.0960 | 1.0500 (1.0800) | 1.0200 (1.0600) | 1.2000 (1.2000) |
*Forecasts as of November 2023. Figures denoted in brackets are the previous forecasts.
- The more than 3.5% drop in the broad-based USD Index (DXY) since early October has brought the focus back to EUR which has climbed 4.2% vs USD over the same period. While EUR’s gains might not have been due to the dollar weakness, there seems to be a positive euro component to the story. Recent survey data out of the euro area such as the November PMIs point to stabilization in manufacturing and following the latest stronger-than-consensus ZEW survey and third successive improvement in German Ifo expectations, the survey data at least (a good proxy for forward looking indicators) seems to be pointing to a “recovery” quadrant whereas the US now stands alone in the “slowing” quadrant. This also seems to be backed by Citi’s Economic Surprise Index (ESIs) for the euro area showing the economy had reached a cyclical bottom earlier this year while the Citi ESI for the US seems to be flatlining and possibly heading lower.
- Given expectations for the economy have been so bearish thus far, a bottoming in euro area manufacturing could signal a near term positive for EUR. However, the primary driver of EURUSD over the medium to longer term is still based on the market expectations for the Fed’s against the ECB’s rates for 2024 and beyond. Historically, the Fed has typically led the ECB in its rates cycle on both the timeline and extent of the move. But earlier this year, markets priced a more dovish ECB rates outlook compared to the Fed’s with a similar number of cumulative cuts discounted in 2024 with the path of cuts being almost identical. This was largely due to weak euro area data with China’s slowdown adding to the dovish sentiment.
- However, markets seem to be having a re-think following the weaker-than-expected US October jobs and CPI reports and the Fed’s decision to turn more neutral at the November FOMC meeting. Market pricing seems to be reverting to the historical norm of the Fed leading the ECB in cutting rates in 2024. This also helped to strengthen EUR against USD. Adding to the mix is the relative pace of Fed vs ECB balance sheet contraction. Here, the ECB has already embarked on a faster pace of balance sheet reduction relative to the Fed since September 2022 and should have also resulted in a stronger EUR. But markets seem to have ignored this in favor of the poor run of data out of the euro area. As euro data strengthens however, relative balance sheet considerations can no longer be ignored and are likely to become a more important driver of FX.
- The strength of the rebound in EURUSD may have limited potential to the year-end, but the durability of the rebound could be affected by uncertainty surrounding Germany’s fiscal position due to the recent constitutional court ruling, and Italian’s fiscal constraints due to its weak economic fundamentals being largely ignored. This potentially augurs well for EUR’s outlook in 2024.
EURUSD – A Solid Rebound Since Early October
Source: Bloomberg, November 28, 2023
