Thought of the day
15.08 - Time to take profits on overweight euro positions
The euro has rallied around 12% year-to-date against the US dollar (USD) and 3% against the Swiss franc (CHF) in the past month. It now trades at close to our six-month forecasts of EURUSD 1.18 and EURCHF 1.14.
We initiated an overweight EURUSD position in our foreign exchange strategy last December, when the US dollar had hit a 14-year trade-weighted peak on hopes for US fiscal stimulus, while the outlook for the euro was clouded by political uncertainty ahead of French and Dutch elections. We believed political concerns would ultimately be overwhelmed by improving Eurozone economic fundamentals, encouraging the European Central Bank to consider a tapering of monetary easing.
In addition, we have held an underweight position in the Swiss franc against the euro since July. We expected that a reversal of safe-haven flows and excess liquidity resulting from the Swiss National Bank's efforts to stem currency appreciation would weaken the franc.
But, while EURUSD and EURCHF could rise further over the long term, their upside now looks limited to us over our six-month tactical investment horizon:
- With expectations much reduced for US rate hikes over coming months, there is potential for dollar strength if the Fed signals a greater willingness to proceed with policy normalization. The dollar could also rebound if the US passes a tax reform package or raises the debt ceiling without incident.
- The extent of the US dollar overvaluation versus the euro now looks less pronounced – down from close to 20% at the start of this year to 7% at present, relative to our purchasing power parity estimate of EURUSD 1.25.
- Similarly, the rally in EURCHF may have run its course for now, with geopolitical tensions stemming from North Korea potentially limiting further upside in the near term.
So, given the euro’s impressive performance, we consider it time to take some profits and are closing our overweight in the euro relative to the US dollar and Swiss franc. For more details, please see our CIO Note published 14 August 2017.