EUR: Recovery from wildly undervalued levels to merely cheap ones - SocGen

The euro has recovered from wildly undervalued levels to merely cheap ones and in due course, it will trade at or above fundamental equilibrium levels against a range of other currencies, but not yet, according to Kit Juckes, Chief Global FX Strategist at Societe Generale.

Key Quotes

“Valuation is probably the biggest source of support for the euro. The 2015-2017 period has seen it trade far below any form of ‘fair value’ thanks to the ECB’s magic cocktail of negative rates and asset purchases. Those drove interest rate differentials to levels which discouraged foreign investment in the euro, while at the same time crowding investors out of European bond markets. The mere idea of policy normalisation has been enough for a forward-looking market to start taking the currency back towards those fair value levels and by the time the ECB delivers on any actual policy tightening, we’d expect to see EUR/USD trade back above 1.25. If the US economic expansion loses steam, why wouldn’t we see a move back to the 1.30-1.40 range in, say, 2019/2020?”

“That’s all well and good, but as the EUR/USD threatens the 1.20 level which we pencilled as our target for an upside overshoot this summer; there’s every reason to be cautious about the short-term outlook. Neither capital flows or trends in relative bond yields justify the rally going on without a longer pause, or even a deeper correction than we’ve seen.”

“The swing from a massive bearish consensus towards the euro to a more bullish one, has happened at the same time as expectations about the economic impact of the Donald Trump Presidency have deteriorated. Hopes of corporation tax cuts, capital repatriation and infrastructure spending have been replaced by fear of government shutdown, so it’s only partly a ‘better euro’ that EUR/USD 1.18 reflects; it’s also a ‘worse dollar’

“Overall, our conclusion is a simple one. We think EUR/USD is heading for 1.30-1.40 on a 1- 3year timeframe; but it’s ahead of itself at this point. A correction would need a catalyst and a long period of range-trading would suffice to take the front out of the market, but the pat from 1.18 to 1.30 won’t be in as straight a line as the path from 1.06 to 1.18.”