Euro Faces Headwinds as Energy Risks Limit Upside

EUR: Peak central bank action in Europe

The eurozone’s dependence on energy price exports should put a curb on EUR/USD upside in our view. We had already argued before the Israel-Iran conflict began that moves beyond 1.1600 started to look too stretched based on previous peaks of misvaluation. At the time of writing, the short-term fair value is just below 1.110 according to our model, and moves below 1.1640 would send the pair beyond the three-standard-deviation upper bound.

Anyway, price action in the coming days will be heavily dependent on oil market volatility and the USD moves. On the eurozone side, the main highlights are the ZEW survey results out tomorrow, and a few speeches by the European Central Bank's Governing Council members. Today, we’ll hear from both sides of the spectrum: hawk Joachim Nagel and dove Piero Cipollone.

JPY: BoJ to hold, but hike chances underpriced

G10 central bank activity this week starts with the Bank of Japan, which is widely expected to keep rates at 0.5% overnight. But the primary focus, alongside any forward guidance, will be on the interim review of Japanese government bond purchase operations. Despite speculation that the BoJ might reduce its quarterly purchases from 400 billion yen to 200 billion yen, it is expected to maintain the current pace.

While the BoJ may not give much away in terms of rates guidance at tomorrow’s meeting, we think the risks are definitely skewed to the hawkish side. In our view, markets continue to underestimate the risks of a rate hike as early as July or September, which are 10% and 25% priced in at the moment.

We think the yen remains a rather attractive hedge at the moment, especially if US equities face more hits from geopolitics. Excessive rallies in oil prices may dent the attractiveness of the yen as a safe-haven, but a hawkish repricing in BoJ expectations should make up for it in our view.