Synopsis:

Credit Agricole anticipates a potential near-term decline in EUR/USD, driven by a correction in the 2-year EUR-USD rate spread. Recent aggressive market adjustments, which have priced in nearly four Fed rate cuts this year, have significantly widened the rate spread in favor of EUR/USD. However, if these rate expectations are corrected, EUR/USD may face downward pressure.

Key Points:

• Current Rate Spread Dynamics:

  • The 2-year EUR-USD rate spread has recently widened to some of its highest levels this year, boosting EUR/USD.
  • This widening is a result of the market pricing in nearly four Fed rate cuts for the year.

• Market Expectations:

  • Credit Agricole believes the current market expectations for Fed rate cuts are overly dovish.
  • If the market adjusts these expectations downward, the rate spread could narrow.

• Impact on EUR/USD:

  • A correction in the rate spread, driven by adjustments in Fed rate expectations, could reduce the support for EUR/USD.
  • As a result, EUR/USD might face additional headwinds and decline in the near term.

Conclusion:

Credit Agricole predicts that a correction in the 2-year EUR-USD rate spread, which has been inflated by overly dovish Fed rate expectations, is likely to exert downward pressure on EUR/USD. Investors should be cautious of potential short-term declines in EUR/USD if market expectations for Fed rate cuts are revised.