‘Grossly Undervalued’ Euro Has Few Reasons to Maintain Rally

  • Euro gained on Trump adviser comments on undervaluation
  • Credit Agricole sees downside for the currency from here

Maher: Euro Levels Reflect Currency's Middle Ground

While measures from purchasing-power parity support the claim by Donald Trump’s trade adviser that the euro is “grossly undervalued”, the shared currency also faces less measurable headwinds from a benign inflation outlook, a dovish central bank and rising political risk that will continue to weigh on its value.

The euro climbed the most in two weeks against the dollar on Tuesday after the Financial Times reported Peter Navarro’s comments, reaching a level unseen since early December. Even after that move, the single currency remains the most undervalued among its Group-of-10 peers, according to an OECD measure of purchasing-power parity.

Still, Credit Agricole CIB and Aberdeen Asset Management PLC are predicting the recent gains may prove transitory as political risks rise in the region and the European Central Bank committed to increasing stimulus until at least the end of this year despite accelerating inflation.

"We see near-term risks tilted to the downside from here," Valentin Marinov, London-based currency strategist at Credit Agricole CIB, said in e-mailed comments. "Political risks could intensify ahead of the elections in the euro zone and the currency should re-couple with the wider spreads in the EGB markets," according to Marinov. In addition, the ECB is likely to remain "resolutely dovish for now" and that should keep the euro real rates and yields low.

The wobble in the dollar’s post-Trump rally has also seen the euro-dollar pair decouple from interest-rate differentials. Swap spreads between the euro zone and the U.S. have traded sideways this month even as the common currency gained almost 2.5 percent versus the greenback. The horizon is also clouded by political risk, with elections in France, the Netherlands, and possibly Italy, seeing anti-establishment candidates attempting to ride the rising tide of global populism.

Other analyst views on the euro include:

  • Aberdeen Asset Management PLC, which has a short euro position against the dollar and yen, says the biggest risk to the expectations of a weaker euro is the ECB. "If the market gets a whiff that tapering could occur in September or even before, it will start to see euro shorts come off," said money manager James Athey.
  • The ECB is unlikely to engage "in an explicit currency war,” Vasileios Gkionakis, a strategist at UniCredit, said in e-mailed comments. “I believe it makes little difference for a central bank, as far as its inflation mandate is concerned, if a currency moves from say 1.06 to 1.10 or a bit higher," he said. The bank says the euro is undervalued by around 10% and sees trading at 1.10 vs USD by the end of the year

TECHNICALS:

  • In the short term, a rising wedge is on traders’ radar as a break either way may mark an extended move after forming a consolidating pattern during the second half of January. If the currency closes above resistance at 1.0775, the high on Jan. 24, the focus would turn to 1.0820. A daily close above the 50 percent retracement of the currency’s drop since Trump’s election may significantly add to the euro’s bullish momentum.

POSITIONING:

  • Offers by real money and interbank names within 1.0800-1.0880 may also support the dollar, according to three traders in London and Europe
  • NOTE: Some information comes from FX traders familiar with the transactions who asked not to be identified because they are not authorized to speak publicly
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