It’s hard enough anticipating the pair’s moves for the coming week, never mind the coming year. Despite the risk of looking silly in hindsight, forming outlooks for the coming year is still a useful exercise, especially as long as one is careful to retain a healthy skepticism.
That said, here’s what the evidence suggests to us about the overall direction of the EURUSD for the coming year.
The following is based on our full four part 2013 global market outlook which you can find here. This is a vastly shorter piece that applies the key parts of the 2013 market outlook to the EURUSD.
OVERALL RISK AVERSION: BEARISH FOR EURUSD
For reasons we discuss in our 2013 outlook of the key market movers for 2013 (see here), the overall tone more likely to favor safe haven currencies, hence the USD over the EUR. The primary drivers of the pressure on risk assets:
- Continued weak global growth
- Less support for risk asset prices from assorted forms of stimulus, due to a combination of:
- Steady or declining stimulus measures
- Diminishing returns from these policies.
- EZ Crisis Risk Underestimated: With most risk asset markets near decade highs (for details see here), it’s clear that markets have not priced in any significant contagion risk from a sovereign or major bank insolvency. While the EU has made progress in calming market concerns about near term liquidity, no one believes there have been any material repairs of the underlying insolvency and competitiveness problems that have caused the crisis. In essence the market is betting that the same temporary measures that have worked in the past will continue to work. That may well be true. However most of the leading global stock indexes are at or near the same highs as when there was NO EZ debt crisis. Markets don’t see any material solvency and contagion risk. While timing the next round of EZ angst may be difficult, it’s reckless to say that it can’t happen in 2013. Yet, that’s what markets are saying.
- US Fiscal Cliff And Debt Ceiling Related Risk Not Priced In: Again, with most indexes near the same highs as when these issues weren’t present appears reckless, even if US debt issues present less of a threat than those of the EU. True, despite all the breathless headlines, markets didn’t remained calm through the recent fiscal cliff wrangle. However Democrats and Republicans had a common interest in getting some kind of deal. Republicans didn’t want all the new taxes, Democrats didn’t want all new spending cuts, and neither wanted to risk blame for all of these hitting at once. As we discuss in Part 1 and Part 2 of our 2013 outlook, there is good reason to believe the coming fiscal cliff and debt ceiling fight could well be more damaging than the last debt ceiling struggle in the summer of 2011.
In sum markets are too vulnerable to some very possible shocks from the EU and US, (without even considering a variety of lower probability risk-off geopolitical events in the Mideast and Southeast Asia) to justify risk asset prices. That sets up a likely pullback for the pair.
BETTER US ECONOMIC DATA FAVORS USD
US economic data is likely to be as good as or better than that of the EU. That favors the USD because:
- It feeds Fed rate hike expectations relative to those for the ECB
- It favors US stocks and bonds over their EU counterparts and so makes investment flows favor USD demand.
- It favors US consumer spending over EU consumer spending
INTEREST RATES: NEUTRAL TO BEARISH FOR EURUSD
We remain skeptical that the Fed is serious about tightening any time soon, and believe markets have overreacted to last week’s unexpected hawkish hints in the FOMC meeting minutes. However the fact that these provoked as much of a reaction as they did highlights just how low rate increase expectations are for the USD. Bottom line, if there is any relative change in rate expectations, it’s likely to be in the direction of higher US rates and so favor the USD.
Any change in relative rate expectations for EUR and USD could well be amplified if the Bank of Japan succeeds in driving the JPY lower over the coming year, because a weaker Yen invites a revival of carry trade. That in turn favors the currency with higher rate increase expectations.
ECB LIKELY TO WIN THE RACE TO DEBASE FOR 2013
TECHNICAL PICTURE: BULLISH MOMENTUM VS. LONG TERM RESISTANCE
As we noted in our prior EURUSD article here, the pair remains in a long term uptrend with evidence that its momentum is alive and well. That said, however, long term resistance around 1.3350 from its 200 week EMA will likely require some kind of fundamental fuel that we have yet to see.
While the pair’s current rally may yet have some life, the above evidence suggests that the pair’s overall downtrend since May 2011 remains intact and the pair is more likely to end 2013 lower.
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