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Investment Research
8 January 2015
FX Strategy
EUR/USD – dark clouds but skies are clearing further out

We have been calling for a lower EUR/USD for a long time but it has moved
faster than we had expected. The collapse in oil prices, political uncertainty and
ECB QE expectations have weighed more on the EUR than we had expected.

Near term, we expect EUR/USD to fall further ahead of an ECB QE
announcement on 22 January and the Greek election on 25 January. Medium
term, rebounding euro area growth and monetary repricing should support the
EUR.

We revise our EUR/USD forecast profile lower. We now forecast EUR/USD at
1.16 in 1M and 1.14 (previously 1.22) in 3M but we maintain the view that
EUR/USD will eventually bounce back, bottoming around 1.12 (1.20) in 6M and
grinding towards 1.17 (1.23) on a 12M horizon.

Leverage funds should stay short EUR currencies; in our FX Trading Portfolio,
we are long USD/CHF and short EUR/GBP. Scandi-based clients with USDdenominated income may consider hedging via knock-in forwards whereas
expenses should be hedged with forwards.
FX economics: euro area lagging but not lost
EUR/USD and Brent oil moving in sync
EUR risk premium set to weigh near term...
Expectations of ECB easing and worries over the outcome of the Greek election later this
month are weighing on the euro, notably fuelled by hints in recent days from Germany
and France that allowing a Greek exit may be an option.
To what extent suggestions that a ‘Grexit’ could potentially be tolerated should Greece
drop austerity measures are empty threats to scare Greek voters ahead of the election is
difficult to assess but FX markets are likely to continue to price in the risk of a Greek exit
ahead of the 25 January election. Notably, the parallel with the Lehman Brothers situation
in 2008 (i.e. deemed ‘OK to fail’) is certainly looming in the background.
Regarding the ECB, we note that markets still seem hesitant to price in significant relief
for the eurozone economy despite widespread anticipation of a sovereign QE programme.
Indeed, inflation expectations have fallen sharply, suggesting markets are not convinced
the euro area will escape deflation any time soon. This said, we expect a sovereign QE
programme to benefit not least the periphery. Therefore, one of the factors that has
weighed on the single currency in recent years – namely, periphery spreads widening –
will cease to be a major worry. We stress, however, that two other factors are also playing
– and will continue to do so – a key role in the latest EUR/USD plunge: oil prices and
Russia.
Source: Macrobond Financial, Danske Bank
Markets
Inflation expectations still low
Source: Bloomberg, Danske Bank Markets
Senior Analyst
Christin Tuxen
+45 45 13 78 67
tux@danskebank.dk
Important disclosures and certifications are contained from page 5 of this report.
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FX Strategy
First, oil markets have seen little relief with prices continuing to fall as a global oil glut is
on the cards. While oil markets have yet to stabilise, we emphasise that oil prices are
likely to be undershooting currently. Crucial for oil-price dynamics these days is that
shale production – a key driver of the current oil price rout – can be started up and closed
down relatively swiftly. This suggests that we will eventually see a floor for oil prices as
producers close down and limit the current oversupply. Thus, to the extent that the fall in
EUR/USD is oil related (causality between the two is a disputed issue though), this
should eventually cease to be EUR negative.
Second, Russia is suffering from the violent oil price fall (alongside Western-imposed
sanctions and self-enforced monetary tightening) and markets are now pricing in the risk
of a Russian default at close to 35% on a five-year horizon (on CDS pricing). While a
default is not our main scenario, the risk of this is in itself a EUR negative given the
unconstructive consequences of this for, notably, the European banking sector. All in all,
this suggests that downside in EUR/USD is largely a story about a EUR risk premium
driven by what we see as largely temporary factors: Greece, Russia and falling oil prices.
...but skies are clearing further out
Although the relative growth picture for the euro area versus the US remains one of US
outperformance in the near term, our economists stress that a range of factors is coming
together to lift eurozone growth later in 2015 (see The Big Picture: Synchronous global
recovery in H1 15, 1 December 2014, for details). Notably, the EUR depreciation since
spring 2014 and an increase in bank lending coupled with extensive infrastructure
spending are adding to an improving European growth outlook. The recent fall in oil
prices is also serving as a relief to European consumers and manufacturers, at least to the
extent that this is driven by a rise in production.
However, in our opinion, a more benign growth outlook will not deter the ECB from
further easing, as inflation is a rather different story: our economists forecast that the
eurozone will stay in deflationary territory in 2015 on average, even as oil prices may
bottom out in H1. Indeed, we are well below consensus (and the ECB) on inflation. This
is one reason we expect the ECB to initiate a sovereign QE programme later this month.
Another reason is that the buying of government bonds will now be required to bring the
ECB balance sheet to the informal EUR3trn target.
While the likely announcement of a full-blown QE programme from the ECB would weigh
on the euro via its depressing effects on money-market rates, we stress that the negative
effect for the single currency is likely to be, if not a one-off, at least priced relatively
quickly. This suggests that in the absence of further deterioration of the inflation outlook,
ECB policy should not continue to be a marked EUR negative beyond H1 – not least if we
are right in calling a pickup in eurozone activity and a bottom in oil prices.
European growth set to surprise on
the upside – US in line with consensus
2015
% y/y
D a ns k e
B a nk
2016
C o ns e ns us
D a ns k e
B a nk
C o ns e ns us
USA
3,1
3,0
2,7
2,9
Euro area
1,5
1,2
2,0
1,5
Japan
1,2
1,0
1,6
1,0
China
7,2
7,0
6,8
6,8
Global
3,9
3,8
3,8
3,7
Source: Danske Bank Markets
Deflation is here to stay
Source: Macrobond Financial, Danske Bank
Markets
Fed – ECB divergence pronounced
Meanwhile, the Fed appears determined to hike around the summer with a marked
discrepancy between FOMC member expectations and market pricing of the Fed funds
rate currently. In the view of our rate strategists, this points to the potential for a marked
flattening of the short end of the US money-market curve provided we (and the Fed) are
right in projecting a sustained cyclical upturn.
All in all, our rate strategists’ outlook for USD and EUR rates suggests that relative rates
will be in for a repricing in favour of the USD in H1. Further out, the likelihood that the
Fed will go slow suggests that USD rates will be kept in check, whereas EUR rates may
be in for upside if the ECB is successful in upping inflation expectations via QE.
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Source, Bloomberg, Danske Bank Markets
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FX Strategy
Room for 2Y EUR rates to edge lower
still...
...whereas potential remains in USD
rates
Source: Bloomberg, Danske Bank Markets
Source: Bloomberg, Danske Bank Markets
FX outlook: EUR sky set to clear mid-summer
Short-term financial model suggests
EUR/USD ‘fair level’ around 1.19
Danske Bank Markets forecasts
+1m
Forecast
+3m
+6m
Spot
Exchange rates vs EUR
USD
1.181
JPY
141.2
GBP
0.783
CHF
1.201
DKK
7.4407
NOK
9.14
SEK
9.41
+12m
1.16
139
0.79
1.205
7.4425
9.25
9.40
1.14
139
0.77
1.210
7.4425
9.40
9.30
1.12
139
0.76
1.220
7.4390
9.00
9.20
1.17
147
0.79
1.240
7.4390
8.50
9.00
Exchange rates vs USD
JPY
119.5
GBP
1.51
CHF
1.02
DKK
6.30
NOK
7.73
SEK
7.97
120
1.47
1.04
6.42
7.97
8.10
122
1.48
1.06
6.53
8.25
8.16
124
1.47
1.09
6.64
8.04
8.21
126
1.48
1.06
6.36
7.26
7.69
Source: Macrobond Financial, Danske Bank
markets
Source: Bloomberg, Danske Bank Markets
As a result, we continue to look for EUR downside on a 6M horizon and now expect
EUR/USD to bottom out around 1.12 on a 6M horizon. A lot of this weakness should
materialise on a one to three month horizon though, as ECB and Greek issues play out
and we lower our 1M and 3M forecasts to 1.16 and 1.14, respectively. Thereafter, we
envisage a rebound in the cross to 1.17 in 12M on economic rebound and as Fed rate
hikes are priced in. Our short-term financial models currently suggest that EUR/USD is
not too far from a fair level, estimated to be around 1.19 and little changed in recent
weeks, but in the event of a Greek exit and/or a Russian default, EUR downside is likely
to be much greater than we have been pencilled into our forecast. With markets already
significantly short EUR, the potential for further downside should be limited in the
absence of the above catalysts (see IMM Positioning: Bearish EUR bets back at 'Whatever it
takes' levels, 6 January). Further out, the likelihood of a longer period of unprecedented
divergence between ECB and Fed policy may also make it difficult for EUR/USD to
bounce back substantially.
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FX Strategy
FX strategy: mind the EUR weakness near term
Leverage funds
With a EUR/USD downtrend likely to be extended in the near term, we recommend
investors stay short EUR crosses, notably on a 1-3M horizon. Specifically, as
recommended in FX Top Trades 2015: How to position for the coming year, 2 December
2014, and more recently Danske Bank FX Trading Portfolio: The trend to extend – stay
long USD, short EUR currencies, 5 January, we recommend leverage funds are long
USD/CHF and short EUR/GBP. Indeed, we have just lifted our target on long USD/CHF
(see Danske Bank FX Trading Portfolio: Lift target on long USD/CHF, 6 January).
Real money funds
For Scandinavian-based real money, funds should keep ultra-low FX hedge ratios on
USD exposure. We expect the USD to rally against NOK, SEK and DKK in H1 on
growth and monetary divergence.
Corporates
We suggest that EUR-, DKK-, NOK- and SEK-based corporates with USD income
should hedge via option strategies that retain a profit potential if we are correct in seeing
further USD strength. Specifically, we recommend utilising the relatively high levels in
implied volatility and hedging USD-denominated income via knock-in forwards. We
recommend EUR-, DKK-, NOK- and SEK-based corporates hedge USD-denominated
expenses through FX forwards.
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FX Strategy
Disclosures
This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske
Bank’). The author of this research report is Christin Tuxen, Senior Analyst.
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