Danske Research discusses the USD outlook and highlights 3 factors to watch for USD strength to be halted: trade, Fed and ‘Europe’.
"First, will US-China trade talks set to resume in the week starting 7 Oct result in an interim deal? Market expectations seem rather downbeat and if progress is shown, it should provide some relief for EUR/USD. We do stress that it will likely not be the start of a USD weakness trend in itself, as elevated tensions between the countries suggest that a ‘real’ deal remains far away. The joker here is that the impeachment process against the US President could make Trump try to direct focus elsewhere, e.g. towards landing a deal.
Second, will the Fed end its ‘America first’ approach to policy at the 30 Oct Fed meeting? We expect the Fed to cut rates once more by 25bp (both in Oct and Dec) but also look for a more permanent fix to the latest money-market turmoil, see FX Edge: After the USD liquidity scare, 26 September. This should put short-end US rates back on a declining path and may help resume the carry erosion in USD. In light of current Fed pricing, room remains to price more easing: markets see just one 25bp cut in Q4 while we still look for two," Danske notes.
"Third, developments in Europe (or what is left of it) remain key still. The 17-18 Oct EU summit ahead of the 19 Oct deadline for the UK to ask for an extension will be integral in weighing Brexit risks. In our view, another extension is likely and when granted should hold a hand under EUR (and GBP, of course). What about the eurozone? The ECB will sit on its hands for now, but if inflation expectations continue to edge lower, EUR support could resume, as it will leave the sense of deflation grabbing hold - after all," Danske adds.
"In sum: do not fight USD strength near term, but we maintain that it will not last forever and still see EUR/USD grinding higher as 2020 progress (12M target remains 1.15)," Danske concludes.