The trajectory of exchange rate between Euro and Dollar (Eur/Usd) reflects multiple and often unstable balances. The growth differential, the trend of investments, the divergence of monetary policy and political developments are all parameters to be considered to evaluate future dynamics. Since the beginning of 2023 the exchange rate has moved in a range between 1.05 and 1.11, but how much longer will it fluctuate in this band? And what does it take to see the exchange rate break above or below these levels? Please try to answer these questions below Mabrouk ChetouaneHead of Global Market Strategy at Natixis IM Solutions.
We believe that both cyclical and structural reasons should lead the dollar to appreciate against the euro for a period of three to six months And then to break below the 1.05 level. Beyond this phase, the euro should find its way again thanks to the improvement in the European economic situation that we expect by 2025 and the stabilization of the monetary policy gap.
The implicit volatility of the exchange rate (taken from options markets) is at historically low levels, a sign that investors do not perceive the need to protect themselves (hedge) from the risk of a sharp change in the currency pair. However, any exogenous and anxiety-provoking event, such as the intensification of political tensions, could lead to an increase in this implied volatility, which should push the greenback higher. It is worth noting that safe haven assets such as gold or the Swiss franc (in real effective terms) have appreciated significantly in recent months, presumably in response to the various tensions observed.
Furthermore, the growth differential between the United States and the Eurozone is a factor that should favor the dollar in the medium term. Indeed, the growth differential is expected to remain substantial into 2024, driven by both microeconomic and macroeconomic forces. Projected GDP growth for 2024 ranges from 2.1% to 0.7% on both sides of the Atlantic. The same is true when considering the corporate earnings growth differential of the main companies that make up the main regional stock indexes. In 2024, earnings are expected to increase by 10% for S&P500 companies and 24% for Nasdaq companies, while the consensus expects only 4.5% growth for Stoxx600 companies. These growth differentials should encourage investor inflows into the United States, thus supporting the dollar. In fact, US ETFs have already seen significant inflows since mid-2023.
The direction of US monetary policy is merely a response to a hitherto unstoppable economy. After pricing in over 6 rate cuts for 2024, investor expectations are now aligned with those of FOMC members, who expect 3 rate cuts during 2024. These likely cuts could occur at the end of the second quarter or beginning of the third. However, regardless of the Fed’s timetable, investors believe the ECB will have to be more proactive due to the challenges the Eurozone faces in terms of growth. The difference in perception on the timing and extent of central banks’ reactions is a short- and medium-term supporting factor for the US dollar, which is expected to return to 1.05 within 3-6 months. However, this trend is expected to end by the end of the year and return to around 1.10 as the Eurozone economy recovers in 2025.
