EUR/USD: A Case of Short-Term Undervaluation?
The EUR/USD pair has been largely anchored due to subdued FX volatility post-CPI summer trading conditions. However, our models indicate a short-term undervaluation, supporting a moderately bullish bias for the coming weeks. This raises an interesting question: What is driving this undervaluation?
In my opinion, the key factor is the c.10bp tightening in two-year swap rate spreads, which retain a significantly higher beta than other drivers. This suggests that the market is underestimating the potential for further tightening by the Federal Reserve, which could lead to a stronger US dollar in the long term. However, this also implies that the market is overestimating the immediate impact of any dovish signals from the Fed, which could lead to a short-term undervaluation of the EUR/USD pair.
What makes this particularly fascinating is the potential for a shift in Fedspeak. While the late-August Jackson Hole Symposium may not have delivered a definitive signal, the presence of centrist members who are not typically considered dovish voices could soften their hawkish tone. This could lead to a more dovish message from the Fed, which could in turn lead to a stronger EUR/USD pair.
However, it's important to note that the impact of Gulf headlines on FX remains marginal, and the bar for the dollar to rebuild a strong direct relationship with oil prices remains quite high. Therefore, any meaningful impact on the EUR/USD pair is likely to be limited.
In conclusion, the short-term undervaluation of the EUR/USD pair is an interesting phenomenon that could be driven by a combination of factors, including the potential for further tightening by the Federal Reserve and the possibility of a shift in Fedspeak. However, the impact of these factors on the pair is likely to be limited, and the market may continue to underestimate the potential for further tightening by the Fed.
