At the end of 2014, a broad consensus view loomed over the currency market: The Federal Reserve would move to normalize interest rates while the European Central Bank eased. Such policy divergence was expected to result in parity between the euro and the dollar by the end of this year.
That didn’t happen. This has eaten away at the broad consensus behind the dollar, and taught many investors a valuable lesson about the dangers of the overcrowded trade.
The euro has risen 3.7% against the dollar since the end of November, but remains down more than 9% since the end of last year.
Going into 2016, many on Wall Street still believe the dollar rally will resume and the euro EURUSD, +0.1292% will see parity—in other words, one dollar will fetch one euro. But there are some who believe the U.S. currency has already peaked, and that 2016 will see the euro gradually climb back toward levels it hasn’t visited since the fourth quarter of 2014.
Here’s a roundup of three different views on the dollar.
Citigroup
Year-end forecast: Parity
Number of Fed interest-rate hikes: Four
The theme of monetary policy divergence between the Federal Reserve and European Central Bank will remain the primary driver of the exchange rate in 2016. Citigroup’s view of the dollar rests on the notion that the pace of Fed interest-rate hikes will be faster than what is currently priced into the dollar. There have been some small indications of a pickup in inflation which also haven’t been priced into the market, they argued. Citigroup also sees commodity prices continuing to weaken in the first half of next year, with a slow rebound beginning in the second half. This should also help support the buck.
Europe is facing several tail risks which could weigh on the currency. Elections or potential elections in Spain, Ireland, Austria and Portugal in 2016 could allow politicians with a hostile view of the monetary union to rise to power. The ECB’s ambitious program of asset purchases could sop up a considerable portion of available liquidity in the eurozone sovereign debt market. This could exacerbate volatility in the space, and possibly push out foreign investors—perhaps slackening demand for the shared currency. The eurozone is also still struggling to grapple with an influx of refugees. These all represent downside risks for the shared currency.
UniCredit
Year-end forecast: $1.12
Number of Fed interest-rate hikes: Three
Uni credit's Vasileios Gkionakis argued that the euro-dollar exchange rate has priced in a much more optimistic view of the U.S. economy than can be justified by economic fundamentals. He divides the dollar’s appreciation since July 2014 into two stages: Its initial run-up in the second half of 2014, which was abrupt but justified; and its performance in the first quarter of 2015, when the currency became disassociated from its fundamentals and a speculative frenzy took over. The investing community soon realized too much had been built into the price.
And that process will continue in 2016, he said. In the U.S., growth will chug along at a reasonable pace, while low oil prices and the strong dollar continue to suppress inflation. The Fed has already made it clear to the market that it prefers to err on the side of caution, so it is unlikely that four interest-rate hikes will happen next year—unless there is a strong rebound in commodity prices, Gkionakis said.
HSBC
Forecast: The euro will finish 2016 at $1.20
Number of Fed interest-rate hikes: Two
HSBC’s David Bloom had a spectacular 2015. He very nearly called the dollar’s peak vs. the euro in the spring, arguing that the dollar’s rally had ran its course in a research note published in April. He has been a consistent dollar-bear since. In 2016, Bloom sees the euro strengthening significantly, erasing roughly one-half of its decline since the dollar rally first began accelerating in July 2014.
Bloom’s projection for next year is based on two primary arguments: That investors have already largely priced in the Federal Reserve’s “dovish hike.” And that the European Central Bank is much less tolerant of easing than many economists think. The ECB is guided by rules: It must buy a certain number of German bunds in proportion to the rest of its purchases, he said. Further, it has limited itself to buying bonds that have a higher yield than the deposit rate (which it cut to minus 0.3% in December).
But fundamentally, the dollar won’t strengthen further because nobody wants a stronger dollar, he said. A stronger dollar would amplify the tightening effect of higher interest rates on the U.S. economy, something the Fed most likely wants to avoid. Commodity producers don’t want a stronger dollar because it is contributing to falling commodity prices. And a stronger dollar would only create problems for China as it continues its transition into a consumption-oriented economy, largely because the yuan is tied to the greenback.
“Nobody wants a stronger dollar except a handful of currency strategists,” Bloom said.
No comments:
Post a Comment