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EUR/USD downside potential…but…

FX forecasting is a mugs game at the best of times. If you get it right, most FX market participants will note that a broken clock is right twice a day. If you get it wrong, former Fed Chair Greenspan’s observation that trying to forecast currencies is similar to tossing a coin with regards to outcomes is worth remembering. Having said that, when John Calverley, our Chief Economist, James Chu, our Head of Investment Solutions and I worked at American Express Bank (along with John’s economics team!) we managed to pick up a lot of top 10 forecasting listings in many of the leading surveys. Our current forecasts are below, with short-term EUR/USD losses expected, but a reversion to higher levels expected further out.

This reflects our consensus approach to looking at markets where John’s longer-term views guide us, and we tend to use short-term fundamental factors and technical to duck and dive. As far as forecasting is concerned, consistently beating the forward rate is difficult. One of the banks that was always winning the top forecasting spot in a corporate survey that we participated in stated that their forecasts were the forward rates, tweaked by a few percentage points if they had a view.

Things can get interesting when we split our talks between fundamental and technical views of course. The chart below goes back to the start of EUR trading and shows what I believe to be a key top in the EUR/USD. The extension target from this pattern (when the spot rate turned below the rising blue line in late 2014/early 2015) points back to the all-time low near $0.82. This is taken from the difference from the top (near $1.60) to the trendline at that time (near $1.18), extended from the breakpoint (near $1.22), pointing to $0.80.

A key factor in FX markets is momentum of course. We tend to look at longer-term indicators for long-term views and risk management, and keep the short-term indicators for short-term risks and outlooks. The chart below shows a simple indicator that uses the difference between the 50-week moving average and current spot rate. Even as daily RSI’s and other indicators chop around, this indicator shows that there is still plenty of room on the downside as far as weekly momentum goes.

We also like to look at other markets for directional clues sometimes. In the case of FX rates, ‘carry trade’ flows can matter, and if you can get paid a lot more to hold one currency and fund this with another currency, this can be important. The chart below shows the spread between the US 10-yr. bond yield and the German bond yield as an indication of carry potential. Everything from overnight rates, 1-month to 12-month deposit rates and other bond and swap rates can be used, of course. But the 10-yr. bond spreads is a very accessible way to look at this. At the moment the spread (red line) is around -190 bp. A sustained turn below the -200 bp zone would leave -400 bp and lower at risk – which could build more ‘carry pressure’ on the EUR.

In our latest Monthly Insights publication we pointed out that it was easier being bullish on the USD when the EUR/USD was near $1.20 than it is now (near $1.05). Participants at the two talks that I gave at the joint STA/ACI webinars in 2021 heard why we were looking for the USD to firm. The case for a softer short-term EUR was also made at our March talk at the UK CFA FX group webinar. However, the last few months have seen more and more analyst and media headlines talk about the ‘King Dollar’ and the notion that this will extend is now pretty much entrenched.

History (and we have a lot of that at Tricio!) has shown us that as market analysts get complacent in a view, things can get tricky. For now though we will be happy enough to keep to the view that on balance the EUR/USD spot rate could fall further in the short-term. At the back of our technical mind we see that big top that formed. But we note big chart support at the $1.03 area and parity as a potential stumbling block just below this. What the ECB will or will not tolerate is a guessing game. We know they moaned at $1.20, will they moan at parity? The US side of the picture is unclear as well. The Fed has the tools but Treasury calls the shots. A super strong USD will lean against inflation risk to some degree, and will give corporations something to blame for any revenue misses. Interesting times ahead?

Gerry Celaya,

Chief Strategist



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