EUR/USD Monthly Fundamental Forecast – September 2016

The EUR/USD closed August at the bottom of its recent trading range as the US dollar rallied to 96. The euro is trading at 1.1155 almost flat for the month and is expected to remain this way in September with the ECB and the Fed moving in opposite directions. As the month starts the US will be the focus with the NFP due on Friday but then traders will once again look for fresh news from the Eurozone. As carefully as the Fed may have been treading of late, the contrast between its policies and those pursued by the Eurozone remains significant. The ECB will continue its current asset-purchase program until September 2016, but it has already hinted at its intention to initiate a new round of quantitative easing. However, the positive outcomes of previous policy measures – improved credit and consumption growth – are likely to be eclipsed by the negative effects of the growth slowdown in the emerging economies, including lower commodity prices.

In the short term traders are closely going to monitor the NFP and all US data this month ahead of the Fed meeting late in the month but in between the ECB will steal the headlines. The ECB is not likely to give up the battle against deflation any time soon. Assuming that it may even decide to step up its current asset purchase program, we expect that the increase in the ECB’s balance sheet continues to drive down the euro.  A third factor is that the deflationary forces generated by lower commodity prices apply to both regions, and the market has already largely adjusted its expectations to a very gradual hiking path in the US.

A weaker euro will, however, likely require additional policy efforts on the part of the ECB.

The global currency war we are currently witnessing and on which we have reported extensively over the past year, is ultimately a zero-sum or even negative-sum game. Yet individual countries cannot afford to remain on the sidelines and take the moral high ground; if they do, they will inevitably end up paying the price.

It is difficult, however, to predict at this point how the balance is going to tip. One factor which has a far greater impact on the EUR/USD exchange rate is the extent to which the policies pursued by the Federal Reserve and the ECB will diverge and how the market is positioned. This past spring, it was widely expected that the Fed would be able to increase its policy rate as early as mid-2015, while the ECB’s asset-purchase program was boosting carry trades at the same time. When it became apparent that the Chinese growth slowdown would have a global impact, doubts about a US rate hike grew and the euro-dollar exchange rate climbed back up to 1.15, having previously traded at around 1.05.

Unless the ECB takes countermeasures, a significant depreciation of the renminbi is bound to have an impact on the Eurozone, as evidenced by the volatility in the currency markets since 11 August 2015. With China playing such a dominant role in the region, other Asian countries may have no choice but to follow its policies, at least to some extent. This will cause other Asian currencies to further weaken against the dollar and the euro. Secondly, the markets are almost certain to conclude again that China’s economy is struggling even more than initially assumed, which may cause commodity prices to fall further.

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