The dollar is enjoying an ideal combination of conditions that support it staying below parity, while the euro will see another PMI drop today, supporting the divergence between the US and Europe. We also see downside risks for sterling, and the sell-off continues in the CEE region
US Dollar: Keeping its strength
The dollar has remained well in demand at the start of this week, enjoying a rather ideal combination of a) markets reinforcing their hawkish expectations ahead of Jackson Hole; b) global risk sentiment instability fuelling defensive trades; and c) further rises in gas prices worsening the outlook for other parts of the world (the eurozone in particular). Today, there is no scheduled Fedspeak and investors will instead monitor August’s PMIs across major economies. Some price action in USD-crosses may end up being determined by any divergence in the surveys between the US and Europe, but the broad global macro picture that is currently supporting the dollar seems unlikely to be changed much from data at the moment.
We cannot exclude that some data releases trigger a long-covering effect in the dollar and a correction, but a sustained rebound in most G10 currencies against the greenback seems unlikely to us at this stage. Hawkish expectations heading into Fed Chair Jerome Powell’s speech on Friday at Jackson Hole should keep a fairly solid floor under the dollar for now, and probably pro-cyclical currencies (European FX in particular) on the back foot as the global risk environment remains choppy.
We may see 110 in DXY by the end of the week, and even at that level calling the dollar peak would prove risky.
Euro: Time to stabilise below parity?
EUR/USD suffered another sharp drop yesterday, as a breach of parity led to a break below 20-year lows. While the move likely brought the pair further into short-term undervaluation territory, we must reiterate two important points. First, a prolonged short-term undervaluation, so a risk premium, is not unwarranted considering the unprecedented risks to the eurozone’s economic outlook caused by seemingly unstoppable energy price increases. Like in previous instances – e.g. the Greek crisis, and Italian political turmoil – that risk premium can remain priced into EUR/USD for several months.
The second point is on medium-term valuation. As recently discussed, the shock to the eurozone’s terms of trade means that a EUR/USD trading moderately below parity is not cheap in real terms when economic fundamentals are taken into account. Another factor to take into account is the potential readjustment of Asian central bank reserves which may include selling EUR/USD after dollar-denominated interventions to support local currencies.
A key question is whether the ECB will start discussing active support to the currency now that we have broken decisively below parity. We’ll hear from Fabio Panetta today in a scheduled speech, but keep an eye on any unscheduled remarks by hawkish members that may well become even more vocal on the weak euro. On the data side, today’s PMIs will be the main highlight of the week, and our economists expect another drop after July’s grim readings, which may leave EUR/USD vulnerable to the 0.9800-0.9850 area.
Pound Sterling: Remaining fragile
Rising energy prices should have put pressure on UK PMIs too, and this may keep the pound without any real solid floor against dollar appreciation. Downside risks to GBP/USD remain quite elevated, and a move to the 1.1500 mark (last seen during the March 2020 flash crash) now looks like a tangible possibility.
EUR/GBP should instead keep trading in tighter ranges, as markets see the eurozone’s and the UK’s economic outlook following similar rocky paths. Oscillations within the 0.8400-0.8500 range may continue to rule in the near term.
Disclaimer: This publication has been prepared by ING solely for information purposes irrespective of a particular user's means, financial situation or investment objectives. The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Read more