Euro: Who killed the albatross? – SocGen

Kit Juckes, Research Analyst at Societe Generale, notes that the EUR/USD has traded in a 1.05-1.17 range and averaged 1.11 over the past year.

Key Quotes

“ECB rate cut in March got the EUR/USD to 1.07 but the Fed has done nothing to help the dollar and the clear impression is that ECB action is having diminishing returns, even as the scope for further easing fades away.

10year European real yields are down at -0.8% and have little scope to fall further, which in turn limits EUR/USD downside to what can be caused by a rise in US real yields. They are at 10bp currently, and look to have settled into a fairly tight range since April (10-30bp). That would appear to doom the EUR/USD to a tight range until talk of Fed tightening gathers momentum again (if it ever does). We look for some modest widening in the real rate spread in late 2016 and through 2017, which can take the EUR/USD into the bottom half of this year’s range. And we see a risk that the UK leaving the EU would trigger a sharper move down for the euro. But mostly, we’re resigned to looking elsewhere for our thrills.

There’s a clearer divergence in real yield differentials between the euro area and Japan, and this prompts us to look for some upside in the EUR/JPY in the coming weeks, though it could also reflect a risk premium for the UK’s EU referendum.

The biggest challenges to the euro come from the UK leaving the EU (if that were to be the outcome of the June 23 referendum); or longer-term economic stagnation that further supported capital outflows. The biggest possible support comes from ongoing FOMC inaction and an energy-inspired rise in inflation that sees (German) pressure to start tapering the bond purchases increase. The debate about how the ECB should respond to higher inflation is the single-biggest potential catalyst for euro strength in H2 2016 or H1 2017.”