Danske Research highlights 4 reasons behind its view for a correction in EUR/USD to towards 1.16 over the coming weeks.
"First, to maintain an optimistic EUR view, we have previously suggested to look at the financial canaries in places like ZAR, BRL and TRY vs USD while notably DAX, financials and the travel sector should be leading the recovery. Over the past month, the tailwind from such a tactical rotation have been fading (Chart 1).
Second, the reflation theme also appearsto be stalling in equities: the growth factor keeps accumulating, and the post-earnings season is showing a continued advantage to technology firms - which favours the US.
Third, positioning is well stretched long EUR and short USD, thus there is less scope for a ‘surprise’ factor to run further, everything else equal. Indeed, resilient US consumer and/or job data, or additional fiscal easing in US risk triggering USD strength.
Fourth, valuation is also unfavourable. We revisited valuation in EUR/USD in FX Strategy - EUR/USD to 1.15 on repricing inflation (7 July) and our updated fair value estimate continues to run at 1.07 (based on cross-asset pricing) and 1.05 (based on relative productivity and terms of trade)," Danske notes.
"In sum, COVID-19 infused tailwinds for EUR/USD are fading while structural trends appear to be reasserting themselves, i.e. this time is not materially different (not even in euroland). We still target EUR/USD at 1.16 in 1M and 3M, with a revision of the EU vs US narrative a likely trigger," Danske adds.