Euro / US Dollar Monthly Forcast

The structure remains quite constructive on the monthly chart, with the market having put in 6 consecutive monthly higher lows and potentially now looking for a seventh. The price has also traded above the 61.8% fib retracement off of the major 2008-2009 high-lows, and next resistance in not seen until the 1.5200 area which represents the 78.6% fib retracement off of said move. For now, 1.4175 is critical longer-term support and needs to be broken to end a sequence of consecutive monthly lows and put the pressure back on the downside. Until then, buying dips should be the preferred long-term strategy.

Euro / US Dollar Interest Rate Forcast

Euro/US Dollar interest rate forecasts have turned bullish for the pair as the spread between the two has turned positive with a +8 differential. Interest rate expectations over the next twelve months for the European Central Bank (ECB) rose to 82 from 56, while the outlook for the FOMC eased to 74 from 80. Policy makers on both sides have tried to talk down yield expectations as downside risks remain for both economies, but the ECB’s price stability mandate increases its chances of being the first to begin tightening.

However, the Euro’s continues strength may begin to have a tightening effect on the economy which will allow the central bank to maintain its current accommodative policy. We have started to hear rhetoric from committee members that the currency’s strength could threaten the region’s recovery.  Therefore, if President Trichet delivers hawkish comments at the upcoming rate decision, interest rate expectations could slide bringing the Euro in tow.

Euro / US Dollar Valuation Forecast

The Euro is now the most overvalued of the majors against the US Dollar, trading a full 3508 pips above its PPP-implied “fair” exchange rate. However, the priced-in interest rate forecast has reflected has slowly trimmed the Fed’s advantage over the ECB and the single currency’s momentum is hard to ignore after three consecutive months of forceful gains against the greenback. While the outlook remains bearish from a pure valuation standpoint, the disparity may widen further before a meaningful correction materializes.


What is Purchasing Power Parity?
   
One of the oldest and most basic fundamental approaches to determining the “fair” exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the “fair” EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by Bloomberg. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar.