Morgan Stanley’s (MS) currency analysts have been bearish on the euro for some time, but even they are stunned by the speed at which everything is unravelling, and now they’re downgrading it further
Having reached some of our targets earlier than anticipated,
we have made some changes to our currency forecasts
mainly centered around the euro. We now forecast EUR/USD
to fall to 1.24 by year-end from 1.32 previously. We have also
lowered our EUR/GBP forecast following the Bank of
England’s move to pause its QE program. We see EUR/GBP
at 0.83 by year-end and GBP/USD at 1.49.
Our global currency outlook for 2010 had one major theme
which was a reversal in the “punish the printer” theme. Our
thesis for currencies in 2010 was that the huge excess
liquidity conditions that prevailed in 2009 and drove many
currencies into misalignment would reverse in 2010 as central
banks withdraw liquidity and the US economy outperforms.
We expected exchange rates to move back towards fair
Downgrading Our Outlook for the Euro
We are becoming increasingly concerned about the prospects
for the euro. As Exhibit 4 shows the trade-weighted euro is
overvalued by around 19% according to our models and a fall
towards fair value would seem appropriate from here. The
euro’s overvaluation has perhaps contributed to the growing
strains within the Euro area as some of the weaker
economies would presumably have had weak currencies
through the crisis without the common currency.
However, owing to the ECB’s “passive” QE policy, the euro
has benefitted as the market punished the “active” printers
(USD and GBP) in 2009. We define “active” printers as those
who expanded their balance sheets by buying assets whereas
the ECB supplied liquidity through tenders allowing the market
to determine the demand for funds. The ECB’s exit strategy is
therefore less complex, which is partially why the euro
strengthened last year.