Fundamental Forecast for EUR/USD: Neutral
– Sentiment around the Euro has completely changed over the course of the week.
– European banking stress tests better than expected, although one Italian bank failed.
- Volatility across asset classes, especially FX markets, remains elevated – it’s a good time to review risk management principles.
What a week for EUR/USD, more so than the Euro. EUR/USD gained +1.75%, the best performing EUR-cross, as reality came crashing down: the Euro-Zone (+1.6% annualized) is growing faster than the United States (+1.2% annualized) as of Q2’16. With this startling, unexpected development – around the release of the week’s data, the deterioration in the Atlanta Fed’s GDPNow Q2’16 growth forecast in the lead up to Friday’s US GDP release was a major warning sign, in hindsight – rates markets have turned on their head.
This time last week, markets were pricing in a rate cut by the European Central Bank this year and for the Federal Reserve to raise rates by June 2017:for the ECB, overnight index swaps were pricing in ~53% chance (between deposit rates and the main refinancing rate) of a rate cut by December; Fed funds futures contracts were implying a 65% chance of a rate hike within 12 months. Now, markets are no longer pricing in an ECB rate cut this year – only a ~48% chance per OIS - and the Fed isn’t expected to raise rates until at least January 2018 – the first month pricing in excess of a 60% probability.
The rapid shift in relative economic conditions between the Euro-Zone and the United States was evident in data surprise indexes. Up front, the Citi Economic Surprise Index for the Euro-Zone jumped to +28.3, its highest level since January 7. Similarly, the spread between the Euro-Zone and the United States Citi Economic Surprise Indexes flipped from negative to positive for the first time since April 19, at which time EUR/USD was in the midst of a run above $1.1500; this appears to be a contemporaneous relationship. In other words, EUR/USD may have already turned, and this may be the middle of the move after basing just above $1.0900 post-Brexit. A move up to the June highs near $1.1400 may be in the near-future.
