Currencies outlook

The USD may benefit near term from looming Fed tapering and persistent Covid worries into autumn.The EUR will benefit only little as a cemented dovish ECB stance keeps the EA rebound from translating into higher rates for longer.
Thomas Hempell

Head of Macro & Market Research

Generali Insurance AM

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Resurgent pandemic worries and hawkish comments by Fed officials have extended the dollar’s strength somewhat further over August. Short-term, USD tailwinds may persist, as the Fed may commit more clearly to a start of tapering at its September meeting amid elevated inflation and a robust labour market recovery.

Yet there are signs that Covid worries may have triggered a mild USD overshoot. The USD is anticyclical, benefitting from global setbacks in growth and risk sentiment. Against these yardsticks, the recent USD bounce seems overdone (top and mid chart). Furthermore, a more persistent USD bounce will need to be backed by rising short-term rates.

These are not imminent, given the Fed’s emphasis that there is no mechanical link between the tapering decision and the timing of rates lift-off. Markets already price a Fed rates lift-off for late 2022 vs. our call for mid-2023.

Furthermore, the minutes to the Fed’s July meeting and Powell’s Jackson Hole speech suggest that the Fed will maintain a high bar for lifting rates, with much of the recent inflation jump to prove temporary.

Shift in USD positions unlikely to extend much further

The USD has also benefited from a substantial shake-out in positioning. CFTC positions jumped from US$35 bn net shorts in January to US$ 5 bn net long in early August. A converse swing in EUR positioning explains much of the reversal in EUR/USD over that period (bottom chart).

With the global recovery dented but not derailed amid progressing vaccinations, we do not expect the shift in positioning to extend into more material USD net longs. Yet the EUR/USD will struggle to gain traction. Apart from renewed Covid worries, the ECB’s dovish strategy twist in summer, which has cemented the low-for-long rate bias, has prevented the EUR from benefiting from the economic rebound in the euro area. We cut our forecasts slightly to 1.18 (3m) and 1.20 (12m).

We mildly upgrade our view on sterling. Given a vanishing vaccination lead of the UK, eroded post-Brexit appeal and a persistent C/A deficit, we do not anticipate any protracted rally in sterling. That said, pencilling in an earlier BoE move and the ECB’s more dovish stance, we mildly lower our EUR/GBP forecasts to 0.86 short and medium term.

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Currencies outlook