Euro US Dollar Exchange Rate Forecast

The break below the 2009 lows at 1.2330 is significant and now exposes a fresh drop over the coming weeks back towards the 2006 lows in the 1.1600’s. Medium-term technical studies are however quite oversold, so we would not rule out the possibility for some corrective upside before the market heads lower. Ultimately, a lower top is sought out ahead of 1.3000, and ideally by 1.2670, ahead of the bearish resumption into the 1.1600’s. 
 

 

 

Continued fiscal crises in the Euro Zone have effectively eliminated speculation that the European Central Bank would soon raise interest rates, prompting further monetary stimulus from the ECB and forcing sharp Euro declines. The EURUSD pair has been relatively disconnected from relative shifts in interest rate forecasts; the threat to Euro Zone stability has been a far more influential market mover than the comparatively small shifts in rate expectations. 

 

It seems unlikely that interest rate forecasts will play any meaningful role in Euro/US Dollar price action through the foreseeable future. The US Federal Reserve is expected to raise interest rates more than the ECB in the coming 12 months. Yet the difference is negligible, and it will be more significant to monitor developments in the Euro Zone than rate differentials. 

 

 

The Euro has closed much of its valuation gap with the US Dollar but prices remain above the PPP-implied “fair” exchange rate by nearly 1000 pips, hinting that further downside is ahead. It is also important to consider that markets tend to overshoot long-run PPP readings and a push into undervalued territory is not out of the question. The long-run case for further losses seems straight-forward: bailing out spendthrift EU members will pile debt onto those countries whose economies drive growth in the region (such as Germany); the financing of this burden will push up borrowing costs and slow economic growth, leaving ECB rates at low levels even as recovery – and thereby the outlook for monetary policy – become increasingly firm in the US. However, this scenario has had ample opportunity to be priced in and the bears may find it difficult to sustain the push lower in the near term without a fresh catalyst. Risk aversion seems to be the only likely candidate to fill that role: with China proactively moving to slow its economy amid fears of asset bubbles and runaway inflation and the EU hamstrung, the US is left as the sole major driver of global economic recovery; if the States are unable to shoulder this burden and the rebound falters, a renewed flight out of risky assets promises to send the greenback higher. Otherwise, an upward correction may prove inevitable before the next major leg of the down move begins. Still, from a purely valuation-oriented standpoint, the bias remains bearish.

 

One of the oldest and most basic fundamental approaches to determining the “fair” exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the “fair” EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by Bloomberg. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar.