EURUSD buy on dips or sell on rallies? BoAML, MS

24 July, AtoZForexBank of America Merrill Lynch argues that due to expectations of renewed policy divergence between the ECB and Fed, EURUSD is sell on rallies. In contrary, Morgan Stanley believes that EURUSD is buy on dips towards the year to date target at 1.16.

EURUSD sell on rallies – BoAML

A week passes but markets remain in wait and see mode past last week’s ECB meeting. Mario Draghi began to prepare market for another QE extension, most likely in September. However, with such expectations already priced in, no one was surprised. BoAML argues that we will have to wait for the ECB to see how far the central bank can go to be able to relax some of the QE constrains to to meet the inflation target.

In the meantime, “we continue to sell EURUSD rallies, as we also expect the Fed’s next hike in December, or early next year at the latest,” Bank of America projected.

The EUR is still vulnerable to Brexit related risks, which stay elevated thanks to the prolonged uncertainty, Brexit negotiations, and any risk-off correction.

Hence, “we continue projecting EURUSD at 1.05 by the end of this year,” BoAML added.

The investment bank thinks that while keeping the capital key as a reference value, the ECB will take some distance from the current QE implementation setup in September by applying it to a wider range of asset classes.

EURUSD buy on dips – Morgan Stanley

“We expect EUR to appreciate moderately this year but then depreciate significantly in 2017,” Morgan Stanley begins. The EUR is one of the currencies driven increasingly by real/nominal yield differentials and EURUSD should trade higher as real EMU rates increase faster than the US equivalents.

Although EMU weakness from Brexit is expected to keep the ECB on defensive, without interest rate cuts larger than the market is current pricing (60% probability of a 10bp ECB cut in 2016 and a 14bp cut in 2017) EUR is going to find it difficult to devalue. Also, extended QE may not translate into EUR weakness as relatively flat yield curves in the EU imply that QE will be less effective at bringing down long-end bond yields.

EURUSD buy on dips or sell on rallies Source: Morgan Stanley research, EURUSD buy on dips

“The political risks that could emerge in 2017 area big reason why we expect EUR to weaken,” MS added. Next year we will have general elections in Germany and France. Markets could start debating the future of the EUR should we have an increased proportion of votes won by populist parties.

Also see: New S&P 500 highs; Can equity market rally continue?

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