Slowing inflation in the euro zone and fading optimism about the region's economic growth led to the euro's worst monthly performance since April 2022. The euro has fallen about 3% against the dollar in May, falling from a one-year high to just below $1.11 at the start of the month to around $1.07, where it has been hovering.
However, despite the headwinds, investors are increasingly inclined to view the renewed weakness of the euro against the dollar as a buying opportunity, on the grounds that the Fed is likely to pause interest rate hikes in June. Traders are betting the Fed will finish raising rates by the end of July. At the same time, the European Central Bank (ECB) is only expected to turn to rate cuts late next year after raising rates and keeping them at their highest level in more than two decades - making the euro an attractive long-term bet.
Geoff Yu, senior currency strategist at Bank of New York Mellon, said selling the euro as it did a month or two ago was no longer easy and the peak of the euro's decline had already been seen.
Sam Lynton-Brown, global head of macro strategy at BNP Paribas, said it was a good time to buy the euro on dips rather than sell on rallies. One year from now, the EUR/USD is expected to be above 1.10, and there is no expectation that the pair will fall below 1.05 and stay there. Despite recent pressure, the euro still has room to rise as more European bonds emerge from negative yields, dampening the relative appeal of dollar-denominated assets, said Sam Lynton-Brown.
A trader in Europe, who spoke on the condition of anonymity because he was not authorized to speak publicly, also said the euro was forming a safety net and was unlikely to break much below 1.05 given that hedge funds and interbank counters were interested in buying it when it did. Early last week, demand for payment options was almost non-existent if the euro fell below that level, and the outlook for the euro was brighter than it was at this time a year ago.
Samy Chaar, chief economist at Lombard Odier Group in Geneva, said the euro could rise above 1.10 in the second half of the year as markets get a clearer view of an imminent U.S. rate cut. While both the ECB and the Fed will have room to cut interest rates as inflation continues to slow, the Fed "has more room to cut," he said.
At the same time, the non-farm data also reinforced that the Federal Reserve may not raise interest rates until July. U.S. nonfarm data were mixed, with payrolls surging in May but the unemployment rate hitting a record high while wage growth slowed. After cancelling each other out, the market is betting that the Fed will keep interest rates unchanged in June, and expectations of a rate hike in July have increased. According to CME's "Fed Watch" : the probability of the Fed leaving rates unchanged in June is 77%, and the probability of a 25 basis point hike is 23%; The probability of keeping rates at their current level by July is 31.2 per cent, the probability of a cumulative 25 basis point hike is 55.1 per cent and the probability of a cumulative 50 basis point hike is 13.7 per cent.
However, Danske Bank is not bullish on the euro, predicting that the euro will fall to 1.03 in 12 months. In the early days of the conflict between Russia and Ukraine, negative yields, recession risks and growing fears of an energy supply crunch pushed the euro below its face value against the dollar for the first time ever, according to Danske Bank. But to be sure, fears of another European energy crisis or an overly aggressive ECB rate hike triggering a decline in growth could hamper bullish forecasts. A new wave of turmoil in the U.S. banking system or a global recession could weigh on the euro in the coming months. Jens Naervig Pederson, head of foreign exchange and rates strategy at Danske Bank in Copenhagen, said: "If the energy crisis breaks out again, then the euro is much more exposed than the dollar. This is one of the reasons why we maintain a negative bias on EUR/USD."
