EUR/USD likely to reach 1.06 by end-2018, says Commerzbank

The EUR/USD is expected to reach a level of 1.06 by the end of next year, having downside potential. Most of the analysts arguing for 1.20-ish levels simply extrapolate the medium-term upward trend in EUR/USD.

Even the description of the recent past as a period of EUR strength is wrong. Market participants are fixated on EUR-USD when assessing EUR strength or weakness. But EUR/USD is a relative price which can rise either because of EUR strength or because of USD weakness. Most often, EUR-USD is more reacting on USD-idiosyncratic factors than on factors concerning Europe’s single currency.

Dissecting EUR/USD into a EUR-specific component and a USD-specific component requires a comparison of the EUR-USD developments with other USD rates and EUR cross rates. The EUR index peaked on May 22. Since then, the EUR has remained weak, which, however, does not clearly show up in EUR/USD as it coincides with roughly equal USD weakness.

In addition, By May 22 the OIS market had priced in a probability of nearly 65 percent for a rate hike before mid-2018, i.e. an ECB interest rate policy that would violate the ECB’s forward guidance (“interest rates to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases”).

Further, market participants have abandoned their bold view by now. Now the 25 percent probability for such a move indicates that this scenario (while still a possibility) is regarded as unlikely. With this less benign rate outlook, EUR has lost parts of its former attractiveness. And it is unlikely that this EUR-friendly factor will return. Meanwhile, ECB President Mario Draghi has emphasized the forward guidance and has done everything to clarify that the European central bankers will stick to it.