Look For A Trend Change For The EUR/USD
Downward revisions in US growth expectations for 2019 could lead to a lower dollar medium-term.
Changes in the medium-term outlook
The US economy will remain a key engine of growth next year. Leading economic indicators remain on track and we foresee the tax reform to reap positive effects early next year.
However, there are three main reasons why we assume that US economic growth will fall back in 2019: the economic cycle will mature, tax stimulus effects could be weaker and the Fed will have hiked rates a number of times by late 2018. US growth should decline from 2.7% in 2018 to 1.9% in 2019. The fall-back should be bigger in the US than in the eurozone.
We have decided to bring forward our rate hikes scenario, as the Fed will probably not miss the opportunity to hike in December, followed by 3 increases in 2018. We no longer expect any rate hikes in 2019. On a net basis, this means one rate hike less in this cycle compared with our previous scenario. This also translates into a lower terminal rate, i.e. 2.25% vs. 2.5% previously. This in turn suggests a lower 10-year yield target for the coming 12 months (revised down from 3% to 2.75%). Our outlook for Europe is a decline in growth in 2019 but more moderate growth compared with the US. We see no reason to change our assumptions for the ECB and expect the end of Quantitative Easing in late 2018, followed shortly by a return of the deposit rate to zero. The refi rate (or policy rate) should only be hiked at the end of 2019. We stick to our 10-year yield target for the German bund of 1% in 12 months.
The revisions in our central bank and yield outlook imply a reduction in the yield differential (or “spread”) between the US and the eurozone. We therefore adjust our 12-month forecast for the dollar and now expect it to weaken in the second half of the year as markets discount the possibility of a fall-back in US growth with the ensuing consequences (mentioned above). The euro should strengthen towards 1.20 in one year. The estimated long-term fair value for one euro (“Purchasing Power Parity” or PPP) provided by the OECD is around 1.30.
Temporary upside for the dollar in the short term
In the short term, we see a number of triggers for the dollar to strengthen due to political, fundamental and technical factors.
The coalition building in Germany remains difficult and could last much longer than expected. The upcoming elections in Catalonia on 21 December could also revive uncertainty. The economic momentum remains strong on both sides of the Atlantic, but the improvement has been stronger in the US of late. Newsflow concerning the tax reform in the US should remain supportive even if the final vote will probably not take place before January 2018. We expect the Fed to announce a further rate hike at its next meeting on 13 December and confirm their intention to continue monetary tightening in 2018. The US central bank is also expected to continue to reduce its balance sheet, heralding upside potential for US bond yields. The ECB announced that it will lengthen the bond purchase program and reduce the monthly amounts. It surprised as the speech was quite prudent.
In terms of technical analysis, the euro has failed to breach the key resistance level (1.185) against the dollar. A test of the next support levels, first around 1.15 then 1.13 (close to the 200-day moving average) is likely. This could then pave the way for a trend reversal during the course of 2018, as explained earlier. We stick to our 3-month target of 1.13.