FX Viewpoint | EUR: Transition time? | Article – HSBC VisionGo
- EUR-USD moved back below the 1.20 mark on the higher-than-expected FOMC dot projection
- In our view, the Fed’s patient approach to policy leaves the door open to some modest USD weakness over the near term
- Yet, some economic and political factors may start to act as EUR headwinds going forwards, as the recovery progresses
EUR-USD moved back below the 1.20 mark, as FOMC median dot now shows two 25bp rate hikes by the end of 2023
It has been a mixed year for EUR-USD, with Q1 weakness largely reversed in April and May. The exchange rate then plunged below the 1.20 mark on the shift in the Federal Open Market Committee (FOMC) median dot (released on 16 June), which showed two 25bp rate hikes by the end of 2023 (vs. Bloomberg consensus of one 25bp hike). In our view, the reflex strength of the USD to the higher-than-expected dot projection is understandable, but this 15-16 June FOMC meeting was an iteration rather than a revolution. (Please refer to FX Spotlight – 17 June 2021 | “FOMC: USD goes dotty” for details.)
The drivers to FX market may undergo a transition that would likely set a ceiling to EUR-USD, in our view
Instead, we believe a key headwind to extended EUR-USD gains beyond 2018 highs is that the personality of the FX market is set to change in the coming months, once the Federal Reserve (Fed) moves more stridently towards its taper later this year and relative interest rates increase their influence relative to risk appetite. It is a transition that is likely to cap much of the USD-driven upside for EUR-USD that has been such a big part of the rally over the past year. However, we are not convinced that this transition point has been reached in full and a still-patient Fed may frustrate the more hawkish elements of the market. All this should leave the door open to some modest USD weakness over the near term.
We believe domestic positives will only be able to elicit some modest EUR strength
For the EUR, domestic positives do exist, including the accelerating vaccine roll out, the economic reopening and associated upswing, and the ground-breaking EU recovery fund. But they will only be able to elicit a modest degree of EUR strength.
Some economic and political factors may start to act as headwinds to the EUR going forwards, as the economic recovery progresses
As we move towards and into 2022, the FX market may become more mindful of some of the headwinds the EUR may face, ironically as the recovery progresses. A paring back of expensive fiscal support for the labour market, an end to debt moratoria and other such steps to shield businesses during the pandemic, and an end to the European Central Bank’s (ECB) flexible Pandemic emergency purchase programme (PEPP), could expose the frailties of the recovery and the lasting economic damage from the pandemic. The FX focus may have shifted from the cyclical upswing to the structural headwinds of debt and pandemic scarring that will be felt differently across the Eurozone. Possible North-South tensions may re-emerge on the need to introduce consolidation measures to restore fiscal sustainability, which may even cause some uncertainty over future EU recovery fund disbursements due to its policy conditionality. Finally, key elections (for example, Germany’s national election in September) could also have significant effects on the EUR in both directions.
 Pandemic emergency purchase programme (PEPP), a temporary asset purchase programme of private and public sector securities, is a non-standard monetary policy measure initiated in March 2020 to counter the serious risks to the monetary policy transmission mechanism and the outlook for the euro area posed by the COVID-19 outbreak.
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