[B]Euro/US Dollar Monthly Technical Forecast[/B]
Very difficult to tell where we go from here with the major caught in the middle of a multi-day range. Ultimately however, the overall structure remains grossly bearish with any medium-term rallies back towards the 1.4000 area to be used as compelling opportunities to build on existing short positions. The market has been chopping around over the past few weeks and we expect the chop to continue with key shorter-term levels to watch above and below coming in by 1.3740 and 1.2885 respectively.
[B]
Euro/US Dollar Interest Rate Forecast[/B]
Relative US Federal Reserve and European Central Bank interest rate expectations have had little impact on Euro/US dollar price action. Instead, markets remain focused on whether the ECB will follow in the Fed’s footsteps and enact Quantitative Easing measures in their respective economy. Soft growth numbers and almost-negligible inflation readings arguably give European officials leeway in taking aggressive measures to boost money supply. Yet recent ECB Governing Council rhetoric has been far from uniform. Some members suggest that interest rates may well go below 1.00 percent and special measures are imminent, but others see far less urgency in taking drastic action.
The end result is that European monetary policy outlook remains especially uncertain, and such uncertainty has helped keep the Euro in a wide trading range against the US Dollar. Overnight Index Swaps suggest that the Euro will most likely maintain its interest rate advantage over the US dollar, but headline yields hardly paint the entire picture. It is easy to claim that the US Federal Reserve will be extremely slow in decreasing its aggressive monetary policy stimuli; the key question is whether the ECB can or will follow. Euro/US Dollar outlook could easily shift on clarification in ECB monetary policy outlook.
[B]
Euro/US Dollar Valuation Forecast[/B]
Although the Euro continues to tread water above the 1.2450 level, the single currency remains substantially overvalued, trading nearly two thousand pips above its “fair” exchange rate to the US Dollar. Although EURUSD has seen decisive gains on the back of a rebound in risk appetite beginning in early March, the long-term fundamental picture is supportive of a broadly bearish scenario: a smaller-scale fiscal effort and a deliberately slow approach to monetary easing suggest the Euro Zone’s economic recovery will lag behind that of the US, fueling expectations that the Fed will be first to raise interest rates and boost demand for greenback. That said, technical positioning suggests a deeper bullish correction may lay ahead before the value gap can begin to be corrected.
[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 pairs that are undervalued against their PPP exchange rate have the size of the value gap denoted in [U][B]RED[/B][/U], while those that are overvalued are denoted in [U][B]GREEN[/B][/U].