EUR/USD Monthly Fundamental Forecast May 2012

Outlook and Recommendation

The EUR/USD closed the month well over the 1.32 price at 1.3233 although it did reach a high earlier in the moth of 1.3380.

As we enter May, euro remains well off its 1.2624 January lows. The support from EUR has come partially from flows, particularly deleveraging and repatriation flows. In addition Germany has value, regardless of the road ahead. Finally, the juxtaposition of Fed vs ECB policy is a weight against the USD, as is the economic desire for a USD that is not sustainably strong. However, rising political, economic and market uncertainties combined with negative investor sentiment (the CFTC reports a net US$19 billion short EUR position) is likely to weigh heavily against EUR as we move towards year-end. We hold a EURUSD Q212 forecast of 1.29 and a year-end target of 1.25.  

After a relatively calm start to the year, economic and financial indicators in the euro zone have displayed renewed weakness in recent months. Increased strains in sovereign debt markets have emerged on the heels of mounting fiscal insecurity and social tensions in Portugal and Spain, and to a lesser extent, heightened political risk in Italy and France. Credit default swaps have eased slightly in Portugal (though remain high, at 960 basis points), while the corresponding metrics in Italy, Spain and France are wider by 57, 43 and 25 bps, respectively, over last month. On the real side, the composite euro area PMI shed nearly two points in April, falling to 47.4, with deterioration in both the manufacturing and services indexes.

Meanwhile, the region-wide unemployment rate rose again in March, reaching a new high of 10.9%. Even Germany seems invincibility has come under question; the unemployment registry grew by 19k in April (following a decline of 13k in March), while the manufacturing PMI dropped in April to its lowest level since mid-2009. The preliminary CPI estimate for April indicated that inflation has finally begun to moderate; the annual rate eased to 2.6% y/y following four straight months at 2.7%. The European Central Bank (ECB) expects inflation to remain above the 2% target through year-end, with downward pressure from weak economic activity being offset by sticky food and energy costs and fiscal consolidation measures. Calls for additional monetary easing are likely to multiply over the coming months.

Where as the US recovery has moved to a slightly slower trajectory in early 2012. Real GDP growth moderated to a 2.2% annual rate in the first quarter, down from 3.0% in the final months of last year. Consumers remain reasonably upbeat, despite higher gas prices and persistently weak housing prices. Motor vehicle dealers, for example, reported strong sales through April, driven by rising replacement demand and improved credit availability.

At the same time, a weaker-than-expected March jobs report and April claims data suggest that businesses remain cautious on hiring, which could weigh on consumer confidence and discretionary spending plans over the summer.

Business capital outlays too have moderated in recent months, though this likely reflects some frontloading of purchases ahead of the scaling-back of the accelerated depreciation allowance at the end of last year. In general, strong corporate earnings remain supportive of continued investment in machinery & equipment. Manufacturing activity is strengthening broadly, led  by the automotive and high technology sectors, though weak European demand will hold back the pace of the US export recovery this year.

Central Bank Name: European Central Bank

Date of next meeting or last meeting: May 3

Current Rate: 1.00 % (- 0.25) (held rates and no additional monetary support )

Statement highlights of last meeting: Based on our regular economic and monetary analyses, we decided to keep the key ECB interest rates unchanged. The information that has become available since the beginning of March broadly confirms our previous assessment. Inflation rates are likely to stay above 2% in 2012, with upside risks prevailing. Over the policy-relevant horizon, we expect price developments to remain in line with price stability. Consistent with this picture, the underlying pace of monetary expansion remains subdued. Survey indicators for economic growth have broadly stabilized at low levels in the early months of 2012, and a moderate recovery in activity is expected in the course of the year. The economic outlook remains subject to downside risks.

 

Important economic events for the month of May affecting EUR,CHF, GBP and USD