Not many months ago, the foreign exchange market was anticipating a much weaker euro - perhaps at parity to the U.S. dollar or below parity.
All the ingredients were in place for a weaker euro, with expectations of more rate hikes by the U.S. Federal Reserve versus the European Central Bank's continuing monetary accommodation.
Fears of a potential Eurozone break-up were also lingering, especially before the French elections. So market participants were short euros, along with many currencies, and were quite content to hold those positions based on what we knew at the time.
But parity never happened. And in recent weeks that sentiment seems to have lost steam.
- The market shift started in the U.S., when plans to amend the Affordable Care Act failed.
- Then there was White House chatter about the U.S. dollar being “too strong." That caused many euro short positions to square up.
- Last weekend, the results of the French primary election really took the burden off the shoulders of the euro "bears."
Of course, we are all waiting for the results of the French run-off election on May 7. But the market is already wiping out the uncertainty about a Eurozone break up in the wake of the first round of the French elections.
The U.S. dollar was stronger beginning in November of last year, when Donald Trump was elected president. But that trend has recently reversed.
Market psychology and positioning reflect these new developments. Market bears have given up their forecasts for a much weaker euro and now see a steady to slightly stronger euro going forward. Eurozone growth continues to improve and is close to outpacing U.S. growth
While the market still anticipates the U.S. Fed raising interest rates two more times this year, the market is now anticipating that the ECB will begin to lay the groundwork for eventual tapering and higher Eurozone interest rates - most likely next year.
Our View: From here, it seems as if market dynamics favor a steady, range-bound euro. For the U.S. dollar to regain its footing further, White House initiatives regarding tax reform and another try at amending the ACA will need to gain more traction. If not, then euro bulls could be seeing a stronger euro for quite some time going forward.
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