EUR/USD: A case for a move below parity - SocGen

Analysts at Societe Generale explain that the new US policy mix suggests that more Fed hikes have to be priced and with lasting policy uncertainty and protectionism fears, there are probably enough ingredients to consider the risk of massive new dollar appreciation.

Key Quotes

“If the negative political surprises don’t stop there and have a far more dramatic impact on Europe, the risk to our forecast is that the euro could fall much more.”

“The trigger: under-priced risk of a more aggressive Fed

Donald’s Trump election could become very decisive for the medium-term dollar outlook. His inflationary programme (spending, tax cuts and deregulation) and the associated growth boost are a policy mix that could accelerate the Fed’s pace of tightening. The point is that inflation breakevens are spiking, while the market pricing of the Fed calendar remains very complacent.”

“The recent price action is seriously challenging long-term patterns. The EUR/USD may have broken a major trend line in the 1.06-1.07 region, starting from the 2000-2001 lows and accurately capturing the three increasing bottoms of 2015-2016. These bottoms correspond to a horizontal triple top of the Dollar Index just above the psychological 100 level, above which there is an air pocket. This implies that a slightly lower euro would not break a two-year range but a 15-year trend and that the Dollar Index (the euro weighs 57.6%) would break free in the 100-120 region. The EUR/USD may therefore not stop at the recent 1.05 low but could break parity.”

“Beyond dollar strength, scary euro risks

We have already called for lasting USD/JPY upside, and our central scenario sees the yen underperforming G3, with more USD/JPY bullish potential than EUR/USD bearishness. The BoJ caps Japanese yields, while the ECB tapering expected next year should support Bund yields. This would prevent yen appreciation while offering support to the euro. While a much lower EUR/USD is not our central scenario, the dollar breaking higher, combined with nasty political developments in Europe, could trigger a move below parity.

The case for euro bearishness is tied to concerns that there will be further negative political surprises that could have a dramatic impact on Europe.”