The Dollar has appreciated recently on the back of higher risk aversion. We think this offers a good entry point to go long EUR/$. We see 5 drivers for dollar weakness in the near to medium term:
1) The recovery in global growth expectations is leading to a broader pick-up in risk appetite and a normalization in money markets as our Financial Stress Index continues to highlight. Lower money market rates and reduced dollar funding pressures reduce safe haven Dollar demand and allow Dollar depreciation.
2) Related to the previous point, we expect commodity prices to continue to rise. With the oil-Dollar correlation re-emerging we think that higher commodity prices will lead to a weaker Dollar. As we have shown in the past, the causality typically tends to run from commodity prices to FX.
3) Throughout this recovery in global growth, the US is likely to underperform in terms of domestic demand as the US consumer is adjusting its level of spending lower (and its savings rate higher). The US output gap is estimated to be among the largest of any major country.
4) Together with weaker domestic demand, the FED will likely be more aggressive with monetary easing than the ECB, thus creating conditions for a weaker USD. The rather hawkish tone of the ECB last Thursday supports this argument.
5) The continued talk about the SDR as a new synthetic reserve currency undermines confidence in the currently dominating reserve currency, the Dollar. Note that the SDR basket only contains about 40% USD (37% for the EUR) compared to the current share of about 60% (30% for the EUR) in EM central bank reserves globally. Finally, talk about BRIC countries invoicing their international trade in each other's currencies further questions the future of the Dollar as reserve currency. While be believe that changes are a long way off, these reserve related factors add to the Dollar negative sentiment.
The timing is now opportune for new EUR/$ longs. Driven by the improvement in the rate of global growth, the market has been very aggressive in terms of pricing tighter monetary policy in the US. However, we disagree with this market movement. We think the level of growth will remain below trend and US rates will be kept low for a considerable period of time. If and when expectations for tighter Fed policy get scaled down, the Dollar will likely come under renewed pressure. In addition, our GS Sentiment Index indicates that the speculative long position that had built up in EUR/$ over the last few weeks has been completely washed out.
Finally, despite the fact that the EUR/$ has appreciated sharply, the EUR TWI has been more stable due to relative EUR weakness relative to peripheral currencies, in particular the Pound. This has allowed overall financial conditions in Europe to ease over the last few months as our Eurozone FCI also indicates, mostly due to equity markets strengthening. EUR/$ strength has therefore been much less of a growth hurdle.
We would go long EUR/$ with a stop on a close below 1.3720 for an initial target of 1.45.
GS FX Research
1 comment:
Interesting, but I am surprised that you are calling for a higher Euro. Generally, I agree that the dollar is weak and will weaken. But there are far better opportunities to trade against the dollar ( Australia, NZ, Brazil and other commodity countries). It seems that the Euro v Dollar is a contest of who is the worst of the worst. Also, if GDP to Debt is anything to consider, Europe is in bad shape. Finally, with so many distinct economies in the Euro zone, the currency will have a hard time stabilizing.
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