EUR/USD: Move to parity could be further away - Rabobank

The fact that the EUR/USD spiked to highs close to 1.0653 last week will have worried USD bulls according to the Jane Foley, Senior FX Strategist at Rabobank. 

Key Quotes

“Although the move higher in EUR/USD was clearly exacerbated by thin volumes, it has helped to illustrate that a move to parity could be further away than it appeared a few weeks ago.”

“From its May 2016 low, the USD index is currently trading over 12% higher on expectations of hastening US growth and progressively higher interest rates from the Federal Reserve.  If the USD is to retain its momentum, the Fed will have to break the pattern set over the past couple of years and not disappoint market expectations.  Following its December rate hike, the FOMC indicated that it expects to hike rates three times during the course of 2017.”

“Without question the US labour market has experienced a marked improvement in recent years.  Weekly jobless claims have been below the 300K level for 95 consecutive weeks.  However, while earnings have improved, the growth rate is below the level usually exhibited at this point of the economic cycle.  Following a disappointing -0.1% m/m drop in average hourly earnings in December the market is expecting this week’s release of December labour data to show a bounce sufficient to drag the headline rate to 2.8% y/y from 2.5% y/y in November.  While this would be an improvement, it still suggests that inflation pressures remain relatively well contained.”

“While the Fed is clearly watchful for upside inflation risks, monetary conditions have been tightened considerably in the US recently with the strength of the USD adding to the impact from the movement higher in interest rates across the curve.  In December 2015, the Fed indicated that it could hike rates four times in 2016.  In the event it tightened only once last year.  It is our expectation that the FOMC will only announce one more rate hike during 2017 and that USD strength will have started to reverse by the middle of the year.”  

“Politics is set to be a source of volatility for EUR/USD in 2017.  The USD has already priced-in fiscal policy expansion under a Trump administration while the EUR was shaken in the last months of 2016 by fears of a shift towards the far right (and anti-EMU sentiment) in upcoming elections in the Netherlands, France and Germany.  It is our central view that the far right will not find sufficient support to form a government in any of these elections.  Consequently we see scope for the EUR to be lifted by a relief rally following the second round French elections on May 7.  While we see potential for EUR/USD to dip towards 1.03 in the current quarter we expect a recovery towards 1.05 on a 6 mth view and to 1.10 by year end.”