Will euro/US dollar remain stable?

>> Major currencies could be more volatile around election time

It seems that few things can be described as stable right now: stocks are plunging, bonds are flying and, in the FX market the yen and Swiss franc are surging. But there is one important currency pair that is still asleep : euro/US dollar. It has hardly moved since the start of 2023. Could the volatility we are seeing in other markets right now wake up euro/US dollar as well?

Euro/dollar has hardly left the extremely narrow 1.05-1.10 range since early 2023. That’s a long time in a very tight band. In this time, implied volatility has fallen to below 5% just recently in the 1-month maturity and that’s the lowest we’ve seen since late 2021. Hence it seemed that everything was extremely calm but now risk assets are plunging, government bonds are surging, the yen is flying and the market wonders whether euro/dollar will start to move as well.

The said fact is reflected in the fact that 1-month implied euro/US dollar volatility has surged to over 7% in just the last day-or-so. It is as if the market is saying that, while we know that euro/dollar has not moved for a very long time, the volatility elsewhere could spillover to make euro/dollar fly – or plummet. So, what will it be? Or will euro/dollar continue to tread a weary path between 1.05 and 1.10?

So far, the market can’t decide. Plunges in asset prices like those seen recently will most often lift the dollar against the euro given the greenback’s safe-asset properties but, against that, speculation that the Fed could be far more aggressive with rate cuts seems to be creating some momentum for US dollar weakness against the euro.

Should asset prices plunge much further, the case for safe-asset dollar demand against the euro will increase, but so too will calls for an aggressive Fed response and hence it is not clear that even this scenario will produce real directional movement in euro/dollar. Some discrepancy could develop if the slide in risk assets reveals worrying geographical vulnerabilities within certain financial assets or financial institutions.

We know where some of these vulnerabilities may lie, such as the commercial real estate market in both the US and certain European countries. If these, or other vulnerabilities, create significant disturbance in the US or euro zone we may see the US dollar or the euro succumb.

>> Prospects for the US dollar against major currencies

In addition, the US dollar could come under more pressure than the euro if the Fed does respond aggressively with an inter-meeting rate cut or a 50-bps reduction at the September meeting but, in the Standard Bank’s view, it is very unlikely that we are on the cusp of some sort of policy divergence between the Fed and the ECB.

In short, if the Fed becomes more aggressive with its easing, we’d expect the ECB to do the same as well. The key monetary policy discrepancy lies between Japan and other countries, which is why the yen is surging, the yen-funded carry trade is unravelling and risk assets are plunging. One other point to bear in mind that could keep euro/dollar rangebound is that whatever the disturbance caused by things like Fed policy, carry trade unwinding and stock market implosion, there is still a US election in early November and we sense that longer-term traders and investors will be reticent to go with any euro/US dollar breakout right now just in case the election prompts a swift reversal in the trend.

The bottom line is that the Standard Bank does not expect euro/dollar to suddenly become far more volatile and develop a clear directional trend up or down on account of the tensions we are seeing in other markets at the moment. Brief and modest forays outside the 1.05-1.10 range are certainly possible, even likely, but its longer-term call for euro/US dollar to head towards 1.20 requires things like more stable financial markets, modest and steady Fed rate cuts, a Harris victory in November’s US election for starters, and these things will still take time.