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.
Written by Joel Kruger, Technical Currency Strategist; John
Rivera, Currency Analyst; Ilya Spivak, Currency Analyst for DailyFX.com