fot exchange rates surprising: a change in trend in the Eurodollar market is approaching [perspektywy]
Recent months have seen a continuation of the euro’s decline. It turned out to be slightly larger than our forecast from June due to limited Russian gas supplies to Europe, increased risk aversion and more aggressive-than-expected interest rate hikes in the US. As a result, the EUR/USD exchange rate fell below parity for the first time in 20 years. Currently, in the base scenario, we assume that the EURUSD has already discounted several potential factors that could effectively lower the EUR/USD exchange rate.
These include, above all, increased risk aversion (the energy crisis and capital flight to so-called safe havens), the rapid widening of the interest rate differential between the Federal Reserve and the European Central Bank (so far in favor of the ECB dollar), and the disparity in expectations The economic relationship between the United States and the eurozone (in favor of the dollar as well). However, this does not mean that the EUR/USD exchange rate will automatically move into increments. We assume that for most of the fourth quarter, pressure on the dollar’s appreciation associated with continuing geopolitical (war and energy crisis) and economic risks (global recession) will be significant, although it is likely not to be strong enough to lead to a long-term decline in the price below 0.9370.
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While it is very difficult to point to a moment of reversal in the financial markets, in our opinion we are slowly approaching the Eurodollar market. We believe an increase in the ECB’s determination to fight inflation (the largest interest rate hike in eurozone history in September), fiscal packages in the leading European Monetary Union countries, or the prospect of rate cuts next year in the US. Carry trade terms – over time will shape the strength of the euro. Just like – as in previous years – the moment when the first signs of economic stability appeared (albeit at a low level), which led to market optimism (risk strategy). As a result, while in the fourth quarter, the EUR/USD exchange rate will continue to move below par, at the beginning of the new year we should note a gradual increase in quotations to the level of 1.05 at the end of 2023.
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However, due to the highly volatile and uncertain environment, an alternative scenario cannot be ruled out. In the event of a faster and more steady decline of the EMU economy into a recession, which impedes the ECB rate hike process, despite the intensification of the energy crisis in Europe (stagflation scenario) and at the same time the relatively stable economic situation in the United States , a further decline in the EUR/USD exchange rate below the aforementioned important technical barrier at 0, 9370 is possible (i.e. the level from 2001, i.e. the period of high risk aversion after the bursting of the so-called internet bubble on global stock exchanges).
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Financial Markets, Underlying Bonds
The increasingly violent pace of monetary policy tightening in the US and the Eurozone is crucial to maintaining the upward trend in bond yields.
The third quarter brought amazing changes in the valuation of US and German bonds for such developed markets. At a short pace – as of the beginning of August – the aforementioned bond yields rose by 135 pips. the rules. In the case of the Bund, 120 points. the rules. for treasury bonds. While the direction of the changes did not surprise us and was in line with our expectations, the volume of the movement turned out to be much stronger. As a result, the 10-year-old German’s profitability broke the psychological barrier of 2.0% and hit the highest level in almost a decade. Meanwhile, US 10-year debt peaked at 4.0% in 2010.
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Although, as mentioned earlier, the magnitude of the upward movement in the underlying market returns turned out to be stronger than our expectations, we expect the current trends to continue. Following the narrative of the European Central Bank and the US Federal Reserve, we abandoned our expectations that an increase in the risk of recession in the global economy would quickly mean and end at a lower level than current expectations for the end of the monetary tightening cycle. . Moreover, due to the intensification of the energy crisis in Europe, inflationary surprises intensified. In addition, since the previous report, we have learned the details of a new ECB instrument that aims to reduce pressure on increasing yields on bonds of some member states. As expected, it is intended for the debts of southern European countries and, as a rule, should not limit the growth of the profitability of the Bund.
At the same time, a completely new element intensifying the trend of profitability growth is broader and broader financial support for EU countries, which could lead to increased debt issuance in the coming quarters. For example, France intends to borrow 270 billion euros in 2023. In the case of the Bund, we believe that the increase in yields above 2.70% – in the absence of new factors – may be a moment of a gradual slowdown in growth. Moreover, higher yields should accompany US bonds, although here – due to the more advanced stage of the monetary tightening cycle – the area for the increase is slightly smaller and should fade significantly above the 4.25% level.
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