(Bloomberg) -- The euro may have had a slow start to the year, but that hasn’t deterred its fans.
The common currency has been range bound since the European Central Bank’s January meeting as the fervor about tighter policy that drove it sharply higher in the previous weeks cooled. Now that it appears to have weathered the worst-possible outcome in the March 4 Italian election, bullish views are re-emerging, with Goldman Sachs Group Inc., Morgan Stanley, and ING Bank NV all betting the euro will end the year stronger.
The euro, currently at around $1.23, is one of Goldman’s preferred Group-of-10 currencies, with the bank recommending betting on its advance versus the yen. Morgan Stanley sees the euro ending this year at $1.30, while ING has a “high conviction” call of $1.35 in 2019.
The upbeat views come as the ECB prepares to end quantitative easing by the end of the year and speculation builds that it may increase interest rates in 2019. That helped the euro touch a three-year high of $1.2555 on Feb. 16, amid elevated bund yields. As long as the ECB’s move toward normalization keeps the uptrend in yields intact, the common currency should also continue to head higher, according to Societe Generale SA.
“The euro is bound to rally because of the two-step ECB policy normalization,” said Petr Krpata, a currency and rates strategist at ING. “One step is already underway with the preparation for QE tapering. We think that the next step the market is not fully prepared for is the ECB lifting its deposit rate.”
With the premium paid to investors to hold U.S. bonds over German debt at the highest since at least 1990, bund yields are vulnerable to significant moves higher triggered by policy shifts in Europe, which ING said could prove a powerful driver for the euro. While this may be a story for 2019, with the Dutch bank forecasting the first deposit-rate hike in the middle of that year, the market will likely “front run” this, pushing the shared currency higher later in 2018, Krpata said.
Not Crazy
Despite the euro’s 19 percent ascent against the dollar since January last year, the shared currency remains relatively cheap, so $1.30 is “not particularly crazy,” according to Nomura International Plc’s currency strategist Jordan Rochester, who sees the euro going to $1.40 by the end of 2019.
Not all analysts share this upbeat outlook. The ECB faces a daunting task to withdraw stimulus at a slow enough pace to not jolt markets, with President Mario Draghi’s assuring investors that monetary policy “will remain patient, persistent and prudent.”
That cautious approach in contrast to the Federal Reserve’s plan for a series of rate increases this year helped prompt Rabobank International to recently lower its 12-month euro call to $1.21 from $1.28. The euro-dollar’s key resistance level of $1.25 “will be difficult to breach,” and “assuming the Fed maintains its commitment to higher rates this year, we see a greater risk of an eventual break lower” in the pair, according to Jane Foley, the bank’s head of currency strategy.
Portfolio Inflows
Still, the euro also has factors other than monetary policy in its favor. Euro-dollar is the G-10 pair most sensitive to global equity performance, meaning it would be the “primary beneficiary” in an environment of improving risk sentiment, according to BNP Paribas SA strategists including Sam Lynton-Brown.
Portfolio outflows that have plagued the euro region in recent years are also showing signs of easing, which could help support the euro. “You’ve had around half-a-trillion euros of fixed-income outflows last year,” according to Nomura’s Rochester. “When rates start to climb higher you’re going to have that outflow story diminish, allowing some euro appreciation.”
For ING strategists, the reversal of this outflow story would be the next “big change” for the euro as the ECB withdraws stimulus, setting the stage for the currency to strengthen to $1.40.
©2018 Bloomberg L.P.
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