[B]Euro/US Dollar Monthly Technical Forecast[/B]
After posting life-time highs by 1.6040 in July 2008, the market has reversed course sharply to undergo some significant pullbacks reaching 1.2330 (2008 low, October) thus far ahead of the latest multi-month consolidation. It now looks as though a lower top is firmly in place by 1.4720 (December 2008 high) to be confirmed on a break back below 1.2330. Below 1.2330 will open a fresh downside extension towards initial support by 1.2000-1.2130 (psychological barriers/100-month SMA/50% fib retracement of major 0.8230-1.6040 move), and then to the 1.1640, November 2005 lows further down. Only back above February’s high by 1.3095 delays bearish structure.
[B]
Euro/US Dollar Interest Rate Forecast[/B]
The correlation between the EUR/USD and interest rate outlook continued to weaken as the single currency gradually fell throughout the month despite a slight improvement in interest rate expectations. The ECB refrained from further easing in February which kept market expectations in check as President Trichet in January made it clear that the next policy meeting to watch would be the March “rendezvous”. Risk appetite has been the main driver of price action for the EUR/USD and that correlation is expected to remain under current market conditions.
Nevertheless, traders will focus on the upcoming policy rate decision as it may give insight into the state of the European economy as concerns have emerged that troubles in Eastern Europe will negatively impact their western counterparts. Credit Suisse overnight index swaps are predicting 43 bps of further easing over the next twelve months by the ECB versus expectations that the Fed will raise rates by 41 bps. This is primarily based on the belief that the U.S. economy is best poised to emerge from the current crisis and a dour outlook from President Trichet would reinforce this sentiment. However, an aggressive rate cut by the ECB could minimize the impact of future interest rate expectations and leave risk appetite as the sole driver of future price action.
[B]
Euro/US Dollar Valuation Forecast[/B]
The Euro slid another 1.35% against the greenback to end the month as the third-worst performing currency against the U.S. dollar, and topped the charts as the most overvalued currency in February. Increased turmoil throughout the euro-region paired with expectations for further easing by the European Central Bank is likely to weigh on the exchange rate going forward, and the EURUSD should hold its downward trend in the month ahead as mounting growth concerns continue to drag on the appeal of the single-currency. As the flight to quality continues, the reserve currency is likely to benefit from safe-haven flows, and favors a bearish forecast for the pair.
[B]
What is Purchasing Power Parity?[/B]
One of the oldest and most basic fundamental approaches to determining the “fair” exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the “fair” EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by the Organization for Economic Cooperation and Development (OECD). We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar. Currencies overvalued against the Dollar are denoted in [B][U]RED[/U][/B], while those that are undervalued are denoted in [B][U]GREEN[/U][/B].