EUR/USD
The dollar remained stable against the euro over the summer despite the conflict in Iran, higher oil prices and a more hawkish Fed, partly thanks to positive surprises on the other side of the Atlantic, including stronger-than-expected GDP growth despite the energy shock. Meanwhile, the US economy remains resilient, although a reacceleration in consumer spending over the coming quarters looks unlikely. Looking ahead, we continue to expect a gradual depreciation of the dollar, supported by the euro area's relative cyclical improvement, with fiscal stimulus yet to be fully deployed, and by an interest-rate path that we expect to be more favourable to the euro than markets currently price in. Added to this are the well-known structural vulnerabilities of the US economy, namely its large fiscal and external deficits, although the dollar's pre-eminent status in the international monetary system remains largely intact.
- The dollar remained relatively stable against the euro over the summer. EURUSD traded within its range of the past 12 months, moving in a relatively narrow band of around three cents centred on 1.16 dollars per euro. The exchange rate also remained within the range defined by its long-term historical averages, around 1.12 (10-year average) and 1.22 (20-year average) dollars per euro. This stability reflected a number of offsetting forces on both sides of the Atlantic.
- On the euro area side, economic data surprised to the upside between June and September, with GDP growth proving more resilient than expected in the second quarter despite higher energy prices. In addition, the region's terms of trade did not deteriorate to the same extent as during the Ukraine war.
- In the US, economic data surprised on the downside and showed some signs of weakness through August. Investment linked to AI continues to support activity, but job creation does not appear to be of sufficient quality to allow consumer spending to reaccelerate, with household income growth slowing and the saving rate remaining close to historical lows.
- Risk appetite also remained elevated, while the renewed conflict in Iran provided only limited additional support to the dollar.
- Meanwhile, Warsh's arrival at the Fed and his decision not to provide forward guidance on interest rates weighed on the currency. Although recent weeks have made it clear that the current pace of disinflation is too slow for the Fed, uncertainty over future rate increases remains one of the factors keeping EURUSD disconnected from interest-rate differentials.
- Looking ahead, we continue to expect a gradual depreciation of the dollar, albeit within the range in which it has traded in recent quarters. This view is based on a relative improvement in the European cycle, supported by fiscal stimulus that has yet to feed fully through to activity, and on a very gradual slowdown in the US economy.
- In addition, we expect one further rate hike from the Fed and two from the ECB, compared with the three hikes currently fully priced by money markets for both central banks. Any adjustment of market expectations towards our scenario would weigh on the dollar.
- More structurally, large fiscal and external deficits remain a vulnerability for the dollar. The US Treasury's announcement of buybacks of very long-dated government debt, following the rise in yields over the summer, was a reminder of this. If such interventions limit the adjustment in the bond market, part of the correction is likely to be absorbed by a depreciating dollar.