EUR/USD: still upside through the banking woes

In breve

The Western banking woes in the wake of collapsing SVB in the US and Credit Suisse in Switzerland have pressured bank assets and boosted safe-haven core bonds and the JPY. Yet the greenback did not benefit – the Dollar index (DXY) is even down 3% since March 8 (before reports of severe trouble at SVB).

Highlights:

  • The USD is a countercyclical currency, usually benefitting from global growth weakness and financial stress.
  • Yet barring a severe escalation of banking woes, we expect a weaker dollar and a higher EUR/USD by year-end.
  • The Fed is likely done with its rate hikes as tighter credit conditions kick in and a recession is looming. A pivot as soon as in Q4 will mean that yield gaps vs. the euro area will tighten, a EUR positive.
  • With central banks reaching peak rates and inflation (sluggishly) easing, yield volatility is set to recede, removing a key pillar that drove the USD further into overvaluation in 2022. By contrast, the EUR will benefit from resuming capital inflows, a fading terms of trade shock, and the ECB’s more persistent hawkish tilt.
  • The main risk to our constructive EUR/USD view is the tail risk of a very severe escalation of the banking crisis, with safe-haven flows dwarfing other FX drivers. Should euro area bank stress rise materially and revive the bank-sovereign doom loop, the EUR would suffer more materially.

 

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EUR/USD: still upside through the banking woes
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