Tide of Lower US Rates Propels EUR/USD Higher: A Look into 2024"
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EUR/USD: Lifted higher by the tide of lower US rates
US slowdown is central: Our forecast for a higher EUR/USD next year hangs wholly on the view that the US will slow down, inflation will ease and the Fed will be able to make monetary policy less restrictive. Currently we forecast 150bp of Fed easing starting next May/June. This is premised on tighter financial conditions finally weighing enough on aggregate demand to see US growth converge on the stagnant trajectories, especially in Europe. Our team forecast US growth at just 0.5% next year versus the consensus of 1.0%. Equally, our end year 2024 EUR/USD forecast of 1.15 is slightly above the current consensus of around 1.11. In terms of timing the trajectory, our current bias is that EUR/USD strength will become more apparent from the second quarter onwards. The dollar traditionally performs well at the start of the year and with the eurozone in recession, the first quarter may be too early to see a decisive turn higher in EUR/USD.
ECB could crumble: The headwinds to a EUR/USD rally largely stem from weak eurozone growth and the risk that the ECB chooses to cut rates alongside the Fed. This would limit the expected narrowing in yield differentials at the short-end of the curve. Our team forecast three quarters of negative eurozone growth (3Q23 to 1Q24 inclusive) and full-year 2024 eurozone growth at just 0.2%. We expect 75bp of European Central Bank (ECB) easing in 2024 starting in the third quarter, but clearly the risk is that the ECB eases earlier and the Fed later such that the starting pistol for the EUR/USD rally is never fired. Equally, a failure of European governments to agree on fiscal reform by year-end 2023 could see the re-introduction of the Stability and Growth Pact in early 2024 – an unwelcome arrival in a recession.
EUR/USD looks fairly valued: Our medium-term fair value model suggests EUR/USD is fairly valued down at these lowly levels. In other words, there is not the kind of extreme undervaluation that has supported EUR/USD at these levels in the past. This really does build the case that if there is to be a EUR/USD rally, it will have to be driven by the dollar leg. Away from the Fed easing story there is also the risk of US fiscal deterioration and de-dollarisation – perhaps both slow-burn stories. There is also the small matter of the US election. Most commentators warn of a Trump 2.0 administration being ‘louder’. Depending on how the opinion polls progress, we presume any swing in favour of a second term for Donald Trump to be dollar positive – given the experience of the loose fiscal and protectionist policy agenda during his last stay at the White House.
