Euro expected to recover next year
The euro has potential to bounce back above $1.10 by the end of next year, a level last seen in the early months of the Russia-Ukraine war, before energy and economic concerns dragged the common currency below parity with the greenback for the first time in decades, Deutsche Bank believes.
The rise could happen even without a major change in the geopolitical environment, if — as the bank suspects — the US Federal Reserve errs on the side of easing in the second half of next year and the European Central Bank is still increasing its interest rates. The euro is currently trading around $1.038, more than 8% above its late-September low.
“If this is achieved, even without a shift in geopolitics, this policy divergence [between the two central banks] is regarded as a sufficient condition to secure a EUR/USD recovery to at least 1.10 by late 2023,” Deutsche Bank currency strategists Alan Ruskin and George Saravelos wrote in a note to clients.
On top of that, Deutsche Bank says it would bolster its end2023 forecast for the euro by at least 5 US cents if there were a drastic improvement in the Ukraine-Russia situation.
The flip side is that — in the absence of a major risk event like the market saw earlier this year with the onset of the Ukraine war — the forecasters doubt the US dollar will climb to fresh highs if the Fed’s benchmark tops out around 5%, which is close to what the market is currently pricing in and the more likely scenario.
The US currency could potentially lurch to new highs if sticky inflation prompts the Fed to take its target to 6% or above, but that is not the most likely outcome in Deutsche Bank’s view. The Bloomberg Dollar Spot Index, which measures the greenback against a basket of developed and emerging-market peers, is currently around 6% below its late September high.
Deutsche Bank also sees a possibility of a marked bounceback in the yen if the Bank of Japan shifts its policies. Held down by ultra-easy monetary policies, the yen this year weakened to levels unseen in decades, prompting authorities to prop it up directly for the first time since 1998.
A trend toward higher inflation means the BoJ could choose to adjust its yield curve control policies, which could pull the widely watched dollar-yen pair down by 5-10% in fairly short order.
But that could hurt some currencies that have been performing strongly because of carry trades, which are often funded from lower-yielding peers like the yen, Saravelos and Ruskin say.