Since mid-April it would seem the Euro has known only one direction: southwards. Since then, the single currency has lost 3.5% against the US Dollar and is trading at the lowest level since the beginning of the year – a trend that undoubtedly gives rise to justified questions as to the medium and long-term prospects for the relationship between the two currencies. However, before the Euro bulls throw in the towel, it is worth taking a closer look at what is happening at the moment. First of all, the devaluation of the Euro (to date) has primarily occurred in relation to the greenback. At the trading-weighted level, the single currency is neither moving at a striking level nor have there been any dramatic price losses. Things are very different as regards the US Dollar, as in recent weeks it has gained across the board and scored against all the other G10 currencies. The EUR-USD exchange-rate slide since mid-April is thus not so much the product of a Euro devaluation but rather much more of a Dollar revaluation. In the final instance, the sharp rise in yields on 10-year US Treasuries was probably the key trigger. While the correlation between the USD index and 10-year yields has been very low or even negative in recent months, it has of late risen sharply.
The sudden surge in the Dollar is admittedly taking place at a truly unfavourable point in time. The bulk of investors had already accepted that the currency had little potential upwards and all the more so downwards. They had adjusted their market positioning accordingly in the past few months. The IMM data confirm that speculative short positions in USD recently hit their highest level since 2007. Without doubt, the Dollar revaluation has sent the earnings on many of these positions reeling into the red. The risk of a drastic market correction in the wake of adjustments to speculative positions thus shot up, and this is now unfolding – very clearly in fact in the case of the EUR-USD exchange rate, and yet also across the board. The crunch question now is whether the events of recent weeks will or may change the medium to long-term prospects for the EUR-USD rate. The answer must still be “No”. For although the robust growth trajectory in the US is persisting and the Fed will likely raise its key lending rate again, all of this is already fully factored into prices. In fact, the market at present is actually overly upbeat compared to our forecast at least, as we assume “only” two further rate hikes this year, while the majority of those in the market expect three such steps. On the part of the USA there is thus an ongoing risk of disappointment (not to mention the unpredictability of the US President). As regards the Eurozone, the current situation is unfortunately not as clear: the present deterioration in economic indicators currently falls on fruitful ground given that Euro sentiment is dented anyway. However, we still assume that the situation will steady up again by mid-year and thus smooth the way for a first ECB interest rate hike in mid-2019. This will probably give the Euro renewed zest in the medium term.