EUR/USD be at 1.20 by ECB’s September meeting - SocGen

If Mario Draghi was hoping for peace and quiet over the holidays, recent FX market response to the ECB meeting may have come as a disappointment, according to Kit Juckes, Research Analyst at Societe Generale.

Key Quotes

“There are echoes of 2012-2014 in the way EUR/USD is trading, and they suggest it may be at 1.20 by the time the ECB meets again in September.” 

“EUR/USD continues to move higher in tandem with narrowing yield differentials between the US and the euro area but the currency is moving ahead of the yield differential. How worried should I be? Mr Draghi’s ‘Whatever it takes’ speech in 2012, in particular, reversed the widening we had seen in spreads, and that sent EUR/USD to 1.40. A return to a significant correlation between spreads and the currency would make sense once the QE era ends. If it has already happened, we shouldn’t expect this EUR rally to run out of steam very soon.”

“The combination of asset purchases and negative rates allowed the ECB to break the link between peripheral spreads and the exchange rate, and drive the euro to significant undervaluation. But if the ECB doesn’t want to go on buying assets just to keep the currency down, that creates a dilemma for itself. The currency can’t stay this undervalued if they are going to taper (even if they aren’t going to act imminently), but the appreciation towards fair value will be a drag on inflation. How Mr Draghi and the ECB tackle his euro-dilemma may be the biggest driver of FX trends in 3Q.”

“Real 10yer Bund yields have risen from -115bp at the end of last year, to -79bp today. If US real yields merely remain in this low range as the Fed edges rates up in line with expectations, any further rise in real yields in the euro area is likely to be EUR-supportive.”