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Euro US Dollar Exchange Rate Forecast

Euro US Dollar Exchange Rate Forecast

2010-11-04 19:35:00
John Rivera, Joel Kruger, Ilya Spivak,
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Euro/US Dollar Monthly Technical Forecast

Monthly Chart

Prepared by Joel Kruger

Euro_US_Dollar_Exchange_Rate_Forecast_body_eur.png, Euro US Dollar Exchange Rate Forecast

Prepared by Joel Kruger

The latest break to fresh multi-day highs beyond 1.4160 puts a serious dent in bearish prospects and now likely opens a fresh upside extension towards next critical resistance by major falling trend-line resistance of off the record highs from 2008 by 1.4500. Daily studies are closer to overbought, but still show plenty of room to run, and any setbacks are expected to be well supported by the 10/20-Day SMAs in the 1.3900’s. At this point, only back below 1.3695 would ultimately relieve topside pressures and potentially force a shift in the structure.

Euro / US Dollar Interest Rate Forecast

Currency, Central Bank

Euro,European Central Bank

US Dollar, US Federal Reserve

Net EURUSD Spread

Signal

1-Year Expectations(Basis Points)

35

5

30

Bullish

Yield in 1 Year(Percent)

1.35

0.30

1.05

Bullish

Euro_US_Dollar_Exchange_Rate_Forecast_body_Picture_16.png, Euro US Dollar Exchange Rate Forecast

The spread between U.S. and European interest rate expectations widened to 30 from 15 bps on the back of Fed QE and signs of a sustaining Euro-Zone recovery. Dissipating concerns over the European banking system has opened the door for policy makers to move on interest rates if they deemed conditions warrant action which could lead to an improving yield outlook. However, the ECB continues to maintain that rates are appropriate which has left price action at the mercy of broader trends. Indeed, the pair continues to hold a 60% correlation with equity markets as risk sentiment remains the main driver of price action.

ECB President Trichet following the latest rate decision commented that policy makers expect real growth to continue and the recovery to “proceed.” Yet, inflation risks remain anchored which could limit the outlook for yields as the monetary authority adheres to its price stability mandate. The central bank leader also expressed concerns over the efforts of member nations to reign in their high budget deficits. A reemergence of sovereign debt concerns could start to weigh on the single currency offsetting the impact of broader trends.

Euro / US Dollar Valuation Forecast

EURUSD Valuation Forecast: Bearish

Euro_US_Dollar_Exchange_Rate_Forecast_body_110310_EUR.png, Euro US Dollar Exchange Rate Forecast

The Euro has entered extreme overvalued territory, with spot prices trading 20.7 percent above their PPP-implied fair value. That said, in the absence of another flare-up in sovereign risk, the path of least resistance points toward an expansion of the current disparity as renewed QE from the Federal Reserve tips yield spreads against the greenback while stoking risk appetite, the latter being supportive of EURUSD considering the pair’s firm correlation with the MSCI World Stock Index. On balance, positioning points to a bearish bias but it seems prudent to wait before expressing that view, allowing for a greater mispricing to develop.

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 Bloomberg. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar.

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