EUR/USD seems to hug the 1.06 level. What’s next?
Here is their view, courtesy of eFXnews:
There are two important themes currently apparent in the euro area: 1) the strong recovery in inflation and in the economy, and 2) political risks ahead of the elections.
Both these themes are euro area bond market unfriendly, especially for the market with the election risks. The risk of a Marine Le Pen victory at the French elections is low, but if political shocks are avoided, ECB tapering concerns will likely kick in swiftly. This makes euro area bond investment less attractive even if we and the market expect political shocks to be avoided.
Recent correlations pointing to wider French/peripheral spreads against Germany are EUR negative. If the correlation shifts further towards a crisis correlation, a 50bp widening in the French-German bond yield spread could weaken EUR/USD by 5.6% and it could test the parity.
This is a risk scenario to us, but fragile bond market dynamics in the euro area bond market will likely cap nearterm upside room for EUR, even though ECB tapering expectations should support EUR into H2 barring no political shocks.
In the medium term, we expect EUR outperformance, but EUR is likely to trade heavily for now.
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