Technical resistance: Some believe the Euro may have difficulty moving higher. | Photo credit: Reuters
The euro is trading at its highest level this year against the dollar, and has emerged as the clear winner from recent turmoil in global currency markets, which has destabilised the strong dollar and halted the continued decline in Japan’s yen.
After moving decisively above the symbolic $1.10 level, the euro’s more than 2.5% gain in August has put the currency on track for its best month since November. Traders, so far unfazed by the sudden surge in the yen following a sudden interest rate hike by the Bank of Japan on July 31 and a broad surge in the dollar as expectations of a US interest rate cut grew, are now paying attention. After all, history shows that the $1.10 level is not easy to overcome and as recently as April, some analysts had predicted the euro could weaken to parity. It is now the second-best performing major currency against the dollar this year after sterling. Expected to be modest from here, the gains are nonetheless notable as talk of interest rate cuts by the US Federal Reserve coincides with speculation that further easing by the European Central Bank may be limited due to services sector inflation.
“It’s a rate differential story,” said Volkmar Bauer, currency analyst at Commerzbank.
“Inflation is easing on both sides (of the Atlantic), but the Fed is expected to move a little more aggressively on the downside, and that will narrow rate spreads a little bit and strengthen the euro.” The ECB, which cut rates in June, could cut at least another two to 25 basis points, market pricing suggests.
In contrast, traders expect a 94 bps rate cut at the Fed’s three remaining meetings this year – meaning three 25 bps moves, and a good chance of one big move. This is a change of about 30 bps since the beginning of August; ECB pricing has changed little.
The change came after weak labor market data in the US, which raised recession fears and sent stocks and bonds tumbling. Markets have calmed down since then, but expectations of policy easing remain.
Certainly, not only has the euro strengthened against the dollar in August, but the single currency is the one where there are the fewest complications for traders looking for a relatively safe FX bet. The yen is volatile after the massive carry trade ended. Sterling has risen less in August as concerns over interest rate cuts in the U.K. and French political risks that hurt the euro in June have subsided.
“We have seen some of the risks being removed from the euro, such as the French election,” said Salman Ahmed, global head of macro and strategic asset allocation at Fidelity International.
“Now it’s becoming a story of a clean central bank.”
It is getting harder
However, the Euro may struggle to move higher from here.
Analysts say it is at the top of recent trading ranges and there is little scope for the rate differential to move further in its favour.
Commerzbank forecasts the euro will be at $1.11 by the end of the year, unchanged from current levels. ING forecasts it will be at $1.12 in a month, then back to $1.10, and BofA forecasts it will be at $1.12 by the end of the year.
“My view from the second quarter of 2023 was to play the trading range. You buy the euro at $1.05 and sell when it goes above $1.10,” said Mathieu Savary, chief European investment strategist at BCA Research.
For some people, this can also be a source of profit.
“These are the strongest levels for the euro that you should expect between now and the end of the year,” said Guy Stier, head of developed markets strategy at Amundi Investment Institute, who believes the ECB has a more solid case for further rate cuts than the Fed.
The recent euro zone economic recovery is showing signs of slowing, while an index measuring German investor morale fell by the most in two years in August.
Conversely, the next round of US jobs data could show that July’s weak report was merely a blip induced by Hurricane Beryl.