[B]Euro / US Dollar Monthly Technical Forecast[/B]
The market remains locked in a multi-day consolidation since positing fresh 2009 highs by 1.4340 back in early June. While our shorter term outlook has favored the bearish side (we are short from 1.4180), the medium-term outlook is more uncertain from here and it remains to be seen whether we are looking to put in a medium-term lower top by 1.4340, or a medium-term higher low by 1.3750. A break back below 1.3750 would signal a resumption of the broader bearish structure and expose a fresh drop to the 1.3000 area, while a sustained break above 1.4340 would bring 1.4720-1.4870 back into focus. The 100-Week SMA has been a pretty solid trend indicator and we have yet to close back above the longer-term moving average, which ultimately still keeps the focus on the downside. As such our strategy will continue to be to look to sell into rallies, even towards 1.4340, as another topside failure above 1.4300 could also potentially set up a medium-term double top scenario. As such, our outlook will only ultimately shift on a weekly close above 1.4340 and above the 100-Week SMA.
[B]Euro / US Dollar Interest Rate Forecast[/B]
Euro/US Dollar interest rate forecasts have become somewhat bearish, but recent FX market price action suggests the EURUSD will continue to trade off of risk sentiment in broader financial markets. Indeed, the historically strong correlation between interest rates and FX market price action faded quickly through the onset of the global financial crisis. Overnight Index Swaps predict that Euro and US Dollar interest rates will be roughly equal in 12 months’ time.
Such forecasts should be bearish for the Euro, which currently enjoys a 100 basis point yield advantage over its US counterpart. Yet we believe that these developments may have little impact on the Euro/US Dollar exchange rate. It will be far more important to monitor trends in the US S&P 500 and other key global risk sentiment indicators.
[B]Euro / US Dollar Valuation Forecast[/B]
The Euro remains the most overvalued major currency against the US Dollar, trading nearly three thousand pips above its “fair” exchange rate. Although EURUSD has seen decisive gains on the back of a rebound in risk appetite beginning in early March, a decisive turn may be ahead as stocks show signs of topping having risen to the highest level since August 2004 relative to earnings. Global GDP grew 4.1% in real terms in 2004, virtually every credible forecasting outlet including the IMF, OECD, World Bank, and assorted central banks all call for global GDP to shrink this year. This suggests stock markets are highly overvalued, pointing to a forthcoming correction downward as the euphoria subsides. The long-term fundamental picture is also supportive of a broadly bearish scenario: a survey of economists conducted by Bloomberg suggests US GDP growth will outpace the Euro Zone by an average of 1.43% through the end of next year, pointing to the likelihood that the Fed will lead the ECB in raising interest rates. On balance, a confirmed reversal in risky assets in the near term may open the door for long-term Euro weakness, allowing traders to exploit the vast valuation disparity as EURUSD sinks lower.
[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 Bloomberg. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar.