EUR/USD: Economic and political factors to set a ceiling to the euro

EUR/USD moved back below the 1.20 mark on the higher-than-expected FOMC dot projection. In the view of economists at HSBC, the Fed’s patient approach to policy leaves the door open to some modest USD weakness over the near term. Yet, some economic and political factors may start to act as EUR headwinds going forward, as the recovery progresses.

Domestic positives will only be able to elicit some modest EUR strength

“We believe a key headwind to extended EUR/USD gains beyond 2018 highs is that the personality of the FX market is set to change in the coming months, once the Federal Reserve (Fed) moves more stridently towards its taper later this year and relative interest rates increase their influence relative to risk appetite. It is a transition that is likely to cap much of the USD-driven upside for EUR/USD that has been such a big part of the rally over the past year. However, we are not convinced that this transition point has been reached in full and a still-patient Fed may frustrate the more hawkish elements of the market. All this should leave the door open to some modest USD weakness over the near-term.”

“For the EUR, domestic positives do exist, including the accelerating vaccine roll out, the economic reopening and associated upswing, and the ground-breaking EU recovery fund. But they will only be able to elicit a modest degree of EUR strength.”

“As we move towards and into 2022, the FX market may become more mindful of some of the headwinds the EUR may face, ironically as the recovery progresses. The FX focus may have shifted from the cyclical upswing to the structural headwinds of debt and pandemic scarring that will be felt differently across the Eurozone. Possible North-South tensions may reemerge on the need to introduce consolidation measures to restore fiscal sustainability, which may even cause some uncertainty over future EU recovery fund disbursements due to its policy conditionality. Finally, key elections (for example, Germany’s national election in September) could also have significant effects on the EUR in both directions.”

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