Euro to buckle under resurgent US dollar

The Euro's resilience against the Dollar will fade with recent strength not reflecting the fundamental differences between the U.S. and Eurozone economies.

This is according to a new analysis from Rabobank, the Dutch-based multinational bank, which also finds much of the Euro's recent strength might be the result of a position adjustment following the sharp July-October selloff.

"Fundamentals do not appear to justify the current buoyancy of the EUR," says Jane Foley, Senior FX Strategist at Rabobank, "we expect that it is a function of position adjustment related to the strong sell-off in EUR/USD in recent months."

The selloff in the Euro to Dollar exchange rate from a July high at 1.1275 to an October low of 1.0448 allowed the currency market to adjust to the 'higher for longer' outlook for U.S. central bank interest rates.

It also allowed the market to absorb "a lot of bad news regarding the German economy," says Foley.

Euro-Dollar has since rallied to 1.0657 as the selloff of recent months unwinds and the market reaches a 'peak pessimism' towards the Eurozone.

Gains have this week been supported by a better-than-expected German GDP print and news out Tuesday that inflation has fallen below 3.0%, which lowers stagflation risks. But with core inflation remaining closer to 4.0%, the European Central Bank will likely avoid any discussion of rate cuts.

It was also reported Tuesday that Eurozone GDP for the quarter had registered a contraction of -0.1% q/q. The combination of inflation and growth numbers could allow the ECB to consider cutting rates as early as the first half of 2024, which could ultimately weigh on the Euro.

"The overall picture is one of disinflation in the Eurozone which will promote the view that ECB interest rates have peaked. Indeed, while policy-makers will be reluctant to talk about the outlook for rate cuts as long as inflation remains above the ECB’s 2% target, the market is beginning to speculate about such a move in Q2 2024," says Foley.

By contrast, Federal Reserve rates are seen at the same as current levels in this timeframe. "Fundamentals do not appear to justify the current buoyancy of the EUR," says Foley. Rabobank's economists expect the Eurozone to fall into recession in the second quarter based on data from incoming surveys.

"In view of the stagflationary position of Europe’s largest economy and the recessionary risks facing the Eurozone as a whole, we expect that the EUR’s upside potential will run out of steam over the coming weeks," says Foley.