The currency pair euro/US dollar (EURUSD) lost further ground on Tuesday due to a combination of strong US factory activity, which surged to a near 13-1/2-year high in September, and nervousness following Sunday's independence vote in Catalonia.
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The euro's recent downward trend continued on Tuesday, with the common currency hitting a fresh low of 1.1696 before rebounding toward 1.1738. For CIO strategist Daniel Trum, EURUSD's fresh bout of weakness is rather "a sign of dollar strength" than euro weakness, with strong manufacturing data underlining the US economies' momentum despite recent supply chain disruptions caused by Hurricanes Harvey and Irma.
At the same time, heightened nervousness over the stand-off between the Spanish state and the Catalan regional government and potential consequences for European cohesion are seen weighing on the euro. Spain now faces renewed political turmoil after Sunday's Catalonian vote on independence led to violent clashes between national police and residents. The region's leader might declare independence in the coming days, which Spanish Prime Minister Mariano Rajoy has ruled out accepting.
Despite its recent appreciation, the US dollar has been the weakest G10 currency year to date. However, clear hints by the US Federal Reserve (Fed) at a December rate hike in late September led the greenback higher after several weeks of weakness. While in early September the market saw less than a 25 percent chance of a December hike, higher-than-expected August inflation numbers along with Fed actions have increased that probability to over 60 percent, Trum notes.
"The Fed, like the European Central Bank (ECB) before, has surprised some market observers with its relaxed stance regarding low inflation. So we think a rejuvenation of market expectations for the Fed is now in the cards. This should help stabilize EURUSD in a 1.15 to 1.20 range," he says.
CIO expects more clarity once the ECB decides how to proceed with its asset purchases. It expects the central bank to announce a tapering process on 26 October. It continues to see EURUSD at 1.18 in three and six months and at 1.20 in 12 months with purchasing power parity seen at 1.27.