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We believe that expected strengthening of the U.S Dollar will most likely also be delayed. As fundamentals are still Dollar negative, in our view, it will require changes in the U.S monetary policy to trigger a stronger Dollar. That looks increasingly like a late 2014 story.
Rating agency Fitch put the U.S. on notice for a possible downgrade as lawmakers still struggling to resolve the debt ceiling crisis. In case the U.S. is downgraded, should we expect the U.S. Dollar to drop even lower from the current levels?
We do not think so, as the rating outlook of the U.S. should not impact the Dollar significantly at this stage. Moreover, that is also what we saw when the U.S. was last downgraded. In our view, what is more important is how the downgrade will affect the risk markets. If the risk markets are impacted negatively enough, it might even lead to some support to the U.S. Dollar against selected currencies, and that would mainly be the carry target and high beta currencies.
What are your short and long term forecasts for EUR/USD?
We see very strong arguments for EUR/USD to overshoot even further in the short term. Thus, that means higher probability that EUR/USD could move perhaps even towards the 1.40 over the next couple of months. European equities are also performing strongly. However, there are upside risks to European money market rates because of the decline in excess Euro liquidity and the fact that the Fed postponed QE tapering again. Nevertheless, the biggest risk to that projected rise in EUR/USD is positioning. Unfortunately, CFTC data has not been published during the U.S government shutdown; however, to us it looks like trading accounts or, in other words, the more speculative part of the market is already very long on EUR/USD.
Overall, we do see potential for a further move higher. In the long term we still look for the stronger U.S Dollar, given the very big difference in output gaps across the Atlantic, since we expect the main scenario to be the one where the Fed tightens monetary policy well before the ECB.