"EURUSD is trading at a premium relative to rates and yields. We investigate the reason for this EUR overvaluation and conclude that at current levels EURUSD offers good selling opportunities.
Several factors work in favour of a weaker EURUSD. The Fed is preparing to exit quantitative easing while the ECB debates measures to ease monetary conditions further. The US has laid the foundation for an investment driven economic rebound, while the lack of credit and fiscal consolidation pressure is likely to keep EMU’s economic performance subdued.
Hence, we project EURUSD to not only close the current valuation gap; we also expect wider growth differentials to reduce the relative attractiveness of EUR denominated assets, reversing the EUR inflows seen during summer. We expect EURUSD to initially test 1.29 followed by a decline towards 1.24 later next year.
Positioning is favorable for EURUSD shorts. Real money accounts are running long EUR denominated asset positions on a currency unhedged basis, while the many failed attempts to short the EUR by speculative accounts have made this group of investors cautious. The one-year sum of EMU’s current account, FDI, Equity and Bond net inflows has reached levels where in the past a moderation of inflows has set in, taking the steam out of the EUR advance.
Hans Redeker, Morgan Stanley
