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Euro to Dollar Outlook: Divergence "may add Downward Pressure over Short-term" say MUFG

May 6, 2024 - Written by David Woodsmith


Currency exchange strategists at CIBC expect the Euro to Dollar exchange rate (EUR/USD) will weaken to 1.05 before a recovery to 1.07 at the end of 2024.

MUFG expects net EUR/USD gains to 1.12 after any initial vulnerability.

EUR/USD found support close to 1.0650 during the week and rallied to 1.0770 after weaker-than-expected US data.

The Federal Reserve held interest rates at 5.50% following the latest Federal Reserve policy meeting, in line with consensus forecasts.

Chair Powell noted that the evidence needed to be confident in a sustained inflation decline to target had not been met over the past few months and there would, therefore, be a delay in cutting interest rates.

Powell, however, considered that a further increase in interest rates was unlikely.

As far as data is concerned non-farm payrolls increased 175,000 for April compared with consensus forecasts of around 240,000 while there was a small upward revision for the March data to 315,000 from the 303,000 reported previously.

The unemployment rate edged higher to 3.9% from 3.8%.

Average hourly earnings increased 0.2% on the month, slightly below expectations of 0.3%, with a slowdown in year-on-year growth to 3.9% from 4.1%.

Following the data, markets priced in two rate cuts for 2024 from one previously with close to a 40% chance of a July cut.

ING commented; “None of this is terrible – it really isn’t a 'bad' report – but it is the first time we have seen every part of the report come in weaker than expected for a very, very long time. Consequently, the market is fully discounting a 25bp September interest rate cut once again with a second one before the end of the year.”

The latest ISM business confidence surveys for manufacturing and services were both in contraction for April and below consensus forecasts, raising fresh doubts over the US economy.

MUFG commented; “A turn in the momentum of the economy is of course needed for the Fed to deliver the amount of rate cuts we expect. Because a turn hasn’t happened as quickly as originally expected is not necessarily a reason to abandon that view.”

According to CIBC, US households entered the rate hike cycle with balance sheets in much better shape relative other households in other countries and relative to the pre-2008 days.

It noted substantial de-leveraging after the 2008 financial crisis and the high proportion of fixed-rate mortgages which will limit the impact of higher interest rates.

In this context, it considers that there is the risk that interest rates will have to stay higher than expected previously and that a neutral rate may be as high as 4.0%.

HSBC commented; “Relative rates should offer some support to the USD if other central banks, most notably in Europe, show more dovish momentum in the weeks and months ahead. That remains our central case.”

Markets remain very confident that the ECB will cut interest rates in June, but recovery hopes have dampened expectations of more aggressive action over the second half of the year.

MUFG is more positive on the Euro-Zone outlook; “There is compelling evidence now of better growth conditions ahead which will provide support for EUR at lower levels.”

MUFG makes a contrast between short and medium-term trends; “The break to the downside in EUR/USD is feeding expectations of further declines as the Fed maintains an unchanged policy for longer. That opens up a divergence and although this is fully priced it may add downward pressure to EUR/USD over the short-term. But more US rate cuts than now priced relative to the ECB and the pickup in euro-zone growth will help prompt EUR/USD recovery by year-end.”

According to CIBC; “The ECB is likely to act both ahead and more aggressively than the Fed in 2024. Such a scenario points towards an extension of the negative positioning skew and additional EUR downside, towards 1.05 before finding a durable base and graduated recovery narrative into 2025.”
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