Currencies

EUR/USD to decline again

We expect the euro versus the US dollar (EUR/USD) to continue to decline. This view is based on the outperformance of the US economy and a less accommodating US central bank over time, among other factors. 

 

03/06/2021 – Georgette Boele

Since the start of April, the US dollar index has declined. There are several reasons for this. For a start, the rise in US Treasury yields has come to a halt, and they have declined somewhat. We believe that yields eased, because markets had priced-in elevated inflation and earlier and more aggressive rate hikes in comparison to the stance of the US Federal Reserve. As such, there was a high bar to further momentum in yields. Moreover, yield spreads between the US and the eurozone have narrowed. As yields are one of the most important drivers of direction in currency markets, these dynamics have weighed on the US dollar.

We expect EUR/USD to decline again, but the pace will likely be modest. There are several reasons for this. Reasons related to the US dollar are a place to start. We expect real yields to remain supportive for the dollar going forward. US ten-year real yields will likely rise modestly, mainly driven by lower inflation expectations rather than higher nominal yields. Higher oil prices and US fiscal stimulus have resulted in a rise in inflation expectations. The ten-year breakeven rates are at a level not seen since 2013. We think that inflationary pressures will remain subdued; and therefore we expect inflation expectations to decline. This will result in some upward effect on the dollar. Here, we differ from investors that fear overheating and who are expecting lower US real yields.

In addition, while the US Federal Reserve will likely be slow to start hiking rates, this will still be well before the European Central Bank (ECB) begins. Furthermore, the US economy will strongly outperform the eurozone’s. Financial markets have mostly anticipated the strong economic outperformance of the US versus other countries. US data now needs to show this playing out.

Related to the euro, we expect German government bond yields to decline because the ECB will likely remain dovish, leading markets to price-out rate hike expectations for the coming years. This will result in a widening of the ten-year government bond yield spread between the US and Germany, probably weighing on the euro.

We continue to hold the view that the euro will weaken versus the US dollar for the remainder of this year and next year. The main reasons for our outlook for a weaker EUR/USD are the outperformance of the US economy, the Fed being less dovish than the ECB and the repricing of ECB rate-hike expectations. Our forecast for the EUR/USD at the end of this year is 1.15; and 1.10 for year-end 2022.

Georgette Boele – Senior FX & Precious Metals Strategist

Currencies

Source: Bloomberg

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