The often ridiculed (for some incomprehensible reason) John Taylor of FX Concepts is once again proven spot on with his EUR top call, which came when the European currency was at 1.33, at about the time when Goldman reinforced its long EURUSD call. A few weeks and 6% lower, here is Goldman explaining what they really meant (again). In a nutshell - despite the transitory economic boost driven by a plunging EUR export-boom is over, Goldman is hopeful the lingering effects will remain forever. And Goldman continues to be very bearish on the dollar, for one simple reason: "Our expectations for sizeable [sic] additional QE by the Fed will only add to the Dollar negative mix towards the end of the year." We are waiting for the Jackson Hole announcement with bated breath: rumor is the Chairman has mastered the alchemy process of converting linen to gold, and will commence printing the shiny metal shortly.
From Goldman's Thomas Stolper
Recent EUR Negatives
Since early August three main developments have coincided with the renewed decline in EUR/$: politics, rate differentials and risk sentiment.
On politics, there has been a raft of small news items, which taken together suggest the Euro-zone crisis this spring has not yet been forgotten and market sensitivities remain. Among the headlines that have emerged in recent weeks were the announcement of a general strike in Spain for late September and the later-denied speculation about a new stimulus package, also in Spain, which could have undermined fiscal consolidation efforts. Rumours about potentially large job cuts in Greece on the back of the austerity program highlighted that many people are yet to experience the fully impact of the tightening. And finally some Irish banks were perceived to be under increased pressure once again.
We feel that none of these developments represent material threats to the Euro-zone, the Euro or Euro-zone growth and, as such, we think these news items and rumours should be dismissed on fundamental grounds. However, as we highlighted before, market participants may remain sceptical after the deep impact of the crisis that hit the Eurozone earlier this year. Since early August Greek 5yr CDS widened by about 180bp, Ireland by 100bp and Spanish CDS by about 50bp.
In addition to the political factors, interest rate markets have also played a role. While it has been very difficult to benchmark precisely changes in Euro-US rate differentials to FX moves, there is little doubt that there has been a decent correlation in recent weeks in both returns and levels. And the simple fact is that Eurozone rate markets have outperformed their US cousins for most of August so far. With cross Atlantic spreads slightly less favourable to the EUR, EUR/$ also dropped.
Some of these moves in relative rates may already be related to the asymmetric skew in growth risks. Whereas expectations for the US are very low already, strong activity data in Europe over the summer has left more scope for disappointment. We also continue to expect that Euro-zone growth will slow down from the above-trend momentum shown in recent months, with the fading inventory cycle – lagging relative to the US – as the main driver. The latest PMI data released yesterday already provides a bit of this flavour.
Finally, on the back of continued weak US data and renewed worries about Chinese growth in particular, risk sentiment has been on the back foot again. With correlations between cyclical assets and the Dollar at record levels, this has translated into some additional EUR/$ weakness.
Short Term Outlook – Still Cautious on EUR/$
Much of what has happened to EUR/$ in August so far has been in line with our expectations. Our tactical trades were largely risk neutral as we worried about the unsettled global macro environment and weak US numbers in particular. We also expected more signs of a moderate slowing in Eurozone activity and renewed evidence of some political stress linked to the implementation of fiscal tightening.
And there is a clear risk that these three factors can continue in the near term. The post-holiday period in September is important for political developments. France, in particular, may remain an important milestone – a critically important Eurozone country where a much-needed budget consolidation process has only just started, and where a general strike is already planned for September 7. On the macro front, we will continue to look for further signs of growth moderation in the business surveys due in the next few months.
These remaining political risks, together with more ongoing evidence of a moderate Euro-zone activity slowdown are reflected in our 3m EUR/$ 1.22 forecast.
Medium Term Outlook – Clearly USD bearish
Despite our expectations of shorter-term EUR negative news, the issues facing the US economy remain the bigger issues by far. The recent renewed deterioration in the BBoP data, the renewed deterioration in the labour market, plenty of overhang from the housing market bubble and the need to consolidate fiscal policy, all suggest the economic issues facing the US remain more difficult to solve than finding a solution for the outstanding political issues in Europe. Our expectations for sizeable additional QE by the Fed will only add to the Dollar negative mix towards the end of the year.
Moreover, there is also still scope for positive surprises in Europe, in particular with regards to domestic demand in Germany. All this suggests that ultimately the USD will be heading lower and the EUR likely higher, as reflected in our 6 and 12 months forecasts of 1.35 and 1.38. And, in fact, given the US outlook, more pronounced medium-term USD weakness may have to be factored in to our forecasts than already has been accounted for.
Bottom line is that we may continue to see large swings in EUR/$ in the near future before broader USD weakness becomes the dominating FX theme again.