eur fundamentals

Euro - US Dollar Monthly Technical Forecast

Last month, I wrote that “the decline from 1.6040 can be treated as either a 3 wave decline (wave A) or a 5 wave decline (wave 1 with truncation).  Either way, a large range is probably unfolding now that may last the duration of January.”  The EURUSD is at the bottom of its recent range now.  The long term count still calls for a drop below the 2000 low of .8225 in order to complete an expanded flat that began at the 1995 high of 1.4535.  The fastest part of the decline may begin in February (wave 3 of (C)).  This is assuming that a wave 2 top is in place at 1.4732.  It is possible that wave 2 is still underway as a flat and will not end until price pushes above 1.4732.  A bounce near term is likely regardless whether or not wave 2 is complete.  Resistance begins at 1.3676 is the 50% retracement of the decline from 1.4723, which is defended by monthly R1 (calculated pivot).  The favored outlook is for a rally to this area, then a resumption of the larger downtrend. 

Euro - US Dollar Interest Rate Forecast

The link between European and US interest rate outlook and the Euro/US Dollar has been largely counterintuitive as of late. The EUR/USD has moved almost inversely to shifts in relative interest rate outlooks from the European Central Bank and the US Federal Reserve. Indeed, ECB rate outlook actually improved fairly substantially through January, and the Euro fell sharply all the same. In previous years we saw that major currencies would track movements in interest rate differentials with accuracy. Yet market dynamics have clearly shifted, and movements in the US dollar have been closely linked to financial risk appetite. Given that market risk appetite often moves inversely to central bank interest rate expectations, it is perhaps unsurprising to note that the EUR/USD has lost its link with yield differentials.

Currency traders have arguably increased their focus on interest rate dynamics ahead of the week’s European Central Bank interest rate decision, but it is difficult to claim that bearish EUR/USD yield differential outlook will have an impact on the currency pair itself. Overnight Index Swaps currently predict that the ECB will cut rates by a cumulative 41 basis points in the coming 12 months versus 51bp of rate hikes from the Fed. All else remaining equal, this provides a fairly bearish bias for the EUR/USD. Yet it is clear that other factors such as financial risk appetite may offset any effects from interest rate movements.

Euro - US Dollar Valuation Forecast

Although the Euro has fallen considerably through January, it remains substantially overvalued versus the “fair” exchange rate implied by PPP. There is good reason to suspect that EURUSD will continue to decline: the Euro was the third-worst performing currency against the US dollar in January, with only the high-yielding Australian and New Zealand dollars suffering a greater beating. This is very telling considering it happened not only amid resurgence in risk aversion but also as traders substantially pared back expectations of future rate cuts from the ECB. A move away from risky assets has meant a migration of capital away from higher-yielding currencies into lower-yielding ones, so to see the Euro performing worse than the likes of the British Pound or the Canadian Dollar even as rate cut expectations hint a bottom points to considerable bearish momentum weighing on EURUSD.

What is Purchasing Power Parity?

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 the Organization for Economic Cooperation and Development (OECD). We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar. Currencies overvalued against the Dollar are denoted in RED, while those that are undervalued are denoted in GREEN.

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