By eFXnews.com
In a special note to clients today, Bank of America Merrill discuses the reasons behind the extreme volatility in EUR/USD over these past few weeks which have been particularly challenging for traders and strategists alike. BofA concludes by outlining its current strategic standing on EUR/USD.
EUR/USD: Behind The Extreme Volatility:
"There has been a lot of volatility, but no clear trends to hang our hat on. We put this down to a lack of consistency," BofA argues.
1- Lack of consistency in the data. "US household consumption has remained weak despite continued improvement in the labor market. The persistence of diverging household income and expenditure growth has been puzzling," BofA clarifies.
2- Lack of consistency between theory and the data. "With the US moving toward closing the output gap, but not the Eurozone, theory suggests inflation between the two should diverge. However, US core PCE, which has been declining in the past year, fell to just 1.2% in May while Eurozone core CPI jumped last month to 0.9%, the highest reading in 10 months," BofA adds.
3- Lack of consistency between the market and the data. "The breathtaking Chinese equity rally continues to defy weak data while the dramatic Bund sell-off has ironically coincided with the peaking of positive Eurozone data surprises," BofA notes.
EUR/USD: Where We Stand Now?
"Holding steadfast to our core views Until there is more clarity in the data, we are reluctant to swing for the fences. However, recent volatility has only marginally reduced our conviction behind our three core views," BofA adds.
Lower EUR/USD: "Volatility in Bund yields has been the main driver of EUR/USD volatility lately. We think the recent Bund sell-off is overdone and expect that, at current levels, demand from some real money investors such as bank treasuries and life and pensions to revive. Moreover, net issuance is turning negative in June and will reach -€120bn in July. In our view, EUR/USD will follow Bund yields lower over the next two months," BofA argues.
"The Greek crisis is coming to a head. Our view is that things will likely get worse before they get better. Moreover, notwithstanding the possibility that a Greek exit may be positive for the EUR in the long term, we see a potential messy and protracted divorce as being negative for the EUR in the short term," BofA projects.
"The Ukraine crisis is escalating once again, amid a surge in violence in eastern Ukraine last week that prompted Prime Minister Poroshenko to warn of a “full-scale” Russian invasion. German exports to Russia are already down 30% in 1Q," BofA adds.
"The better-than-expected May nonfarm payroll data, coupled with strong auto sales and accelerating housing market, has led our US economic team to maintain their view of a September Fed hike," BofA argues.
"We are targeting parity before year-end," BofA projects.
Risk. "The biggest risk to our bearish EUR/USD view is
if Eurozone inflation continues to surprise to the upside. Our European
economics team believes the sharp increase in core CPI in May was due
to a combination of seasonal and technical factors. They also expect the
passthrough from euro depreciation into inflation to be modest as
limited pricing power forces importers to absorb increased costs," BofA
warns.
