EUR/USD upside potential remains sizable
Our economics team remains of the view that markets are underestimating the downside risks facing the US economy and that the Fed will need to implement significant rate cuts from the first quarter of 2024. Despite a deteriorating outlook for the eurozone economy, we only expect the ECB to begin to ease policy in the summer of 2024. Based on that, we anticipate the EUR/USD two-year real rate gap narrowing to zero by the end of 2024, allowing the pair to comfortably trade above 1.15.
A broad-based dollar decline should translate into a recovery in the currencies hit most during the period of Fed tightening. We expect Scandinavian currencies to rebound from next quarter, although the Swedish krona’s grim domestic outlook means the road should be bumpier compared to its Norwegian peer.
The Australian and New Zealand dollar need to wait for some recovery in Chinese sentiment before unlocking “recovery mode”, while the pound remains tied to market expectations for Bank of England tightening that we still deem too hawkish. USD/JPY should remain the barometer of market sentiment on US yields: a turn lower is long due on the overbought pair, but may need to wait later this year given the Bank of Japan’s lingering easing bias.
As for emerging market currencies, monetary stimulus will keep the renminbi soft and will also see Asian currencies lag in any rebound against the dollar later this year. Better positioned remain some currencies in the CEE space and Latam (eg Hungary, Brazil) where real rates remain deeply positive despite the start of easing cycles this year.
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