Synopsis:

Danske Bank anticipates continued USD strength in the near term and into the following year, driven by robust US economic data, contrasting monetary policy signals from the Federal Reserve and the European Central Bank (ECB), and heightened geopolitical tensions affecting market volatility.

Key Points:

• US Economic Resilience:

  • The impressive September jobs report underscores the strength of the US economy.
  • Positive economic indicators bolster the USD against G10 currencies.

• Euro Area Growth Outlook:

  • The eurozone faces underwhelming growth prospects.
  • It remains challenging to be optimistic about economic activity in the euro area compared to the US.

• Central Bank Divergence:

  • Hawkish signals from Fed Chair Jerome Powell suggest a less aggressive rate-cutting cycle.
  • Dovish remarks from ECB President Christine Lagarde indicate potential for more rate cuts than currently priced in.
  • Short-term rate dynamics have shifted, favoring a downside in EUR/USD.

• Geopolitical Tensions and Market Volatility:

  • Developments in the Middle East have introduced short-term tail risks.
  • Increased volatility is evident in higher VIX and CVIX indices, reaching levels not seen since April 2023.
  • Rising energy prices contribute to unstable risk sentiment, supporting further USD upside.

• Investor Positioning:

  • Investors have unwound long USD positions since the summer.
  • Danske expects this trend to reverse as investors typically increase USD holdings when volatility rises.
  • Current positioning is less favorable to a bearish USD view than a month ago.

• Outlook on EUR/USD:

  • Danske maintains a downward-trending profile for EUR/USD over the next year.
  • Targets a move toward 1.07 in the exchange rate.
  • Difficult to envisage a catalyst that could reverse recent USD gains in the near term.

Conclusion:

'Danske Bank foresees sustained strength in the USD due to robust US economic performance, divergent central bank policies, and heightened geopolitical risks increasing market volatility. With the eurozone's lackluster growth and the potential for the ECB to cut rates more than expected, the EUR/USD is projected to decline toward 1.07 over the next year. Unless significant surprises in inflation data emerge, the USD is likely to consolidate its gains, and a reversal appears unlikely in the immediate future.