Today we saw the euro hit a fourteen month high against the dollar, breaking stubborn resistance to currently trade above $1.43. We have subsequently seen euro/US dollar forecasts of $1.40, $1.45, $1.50 and beyond amid expectations of an ECB rate tightening cycle.
Despite such forecasts, we hold firm to our view that the euro is overvalued at $1.43 and will run out of momentum fairly soon after tomorrow’s rate rise, assuming that Trichet only announces a 0.25% rate rise and not a 0.5%. We are confident that a 0.5% is too hawkish even for the ECB.
So what are the dollar’s long-term prospects? A much-improved picture of the US economy has emerged from the US, to the extent that we can be quite confident that QEII will not be extended past June. A 2011 Fed interest rate rise has even been mooted by one or two US policymakers; such are the prospects for US growth looking forward. In conclusion, the dollar’s weakness seen in recent weeks is unlikely to last past this summer, as the market prices in a more hawkish Fed stance.
The UK has also enjoyed an improved economic outlook on the back of very strong services data on Tuesday. Some hopes for a May rate rise may have been dashed by today’s release of disappointing manufacturing and industrial data for February but it really didn’t tell us anything we weren’t already aware of. Regardless of today’s figures, expectations of a June rate rise have been strengthened over the past week, which is likely to place the BoE at the front of the queue (a factor that is bound to be sterling positive) following tomorrow’s ECB decision.
Added to a more optimistic view of the euro’s major counterparts, we expect eurozone problems (and indeed the impact of tomorrow’s ECB rate rise in exacerbating those problems), to come under the spotlight in coming weeks. Portuguese bond yields are at 9% and look set to reach new record highs up near 10%, causing many to change their bailout timeframe from a matter of months to weeks. Though we have said this for some time, the cost of their debt really isn’t sustainable and this rate rise could be the straw that breaks the camel’s back as far as Portugal is concerned. In addition, details of a more permanent eurozone-wide bailout facility remain elusive, which has irritated markets in the past and those frustrations could yet return.
Whilst we do think that the euro will drop off from its current highs, we do not think that the single currency will fall too far below the psychological $1.40 mark. We are confident that Asian investment will keep the euro well-supported, that the market has grown a thicker skin to peripheral debt issues, and that a certain degree of bailout crisis has already been priced into the euro. Nonetheless, $1.43 for euro/US dollar at the end of this month would certainly be a surprise.
Richard Driver
Analyst – Caxton FX
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