We see downside risks to EUR/USD below 1.05′

UBS revised its outlook on the currency pair, citing increased downside risks that could push the euro below the 1.05 level against the US dollar. The change in perspective comes as the US economy shows greater resilience to high interest rates than previously anticipated, and geopolitical concerns intensify to levels that are impacting currency markets.

UBS had initially maintained that the EUR/USD would hold steady within a narrow range, with solid support around the 1.05 mark. Investors were expected to view the US dollar as less attractive below this threshold, especially with an anticipated Federal Reserve rate cut in the second quarter. However, UBS now believes that the rate cut may be postponed until the end of the third quarter or later, which could lead to the US dollar appreciating until economic data permits the Fed to lower rates.

The European Central Bank (ECB), in contrast, appears ready to begin its rate-cutting cycle as early as June. This divergence in central bank policies may result in a scenario of US exceptionalism, where the US dollar benefits from a more restrictive Federal Reserve and the ongoing search for safe-haven assets.

The shift in UBS’s stance also reflects recent movements in other currency pairs and commodities, such as the decline in and the rise in oil prices. The prolonged conflict in Ukraine, tensions in the Middle East, and the upcoming US presidential election are contributing to a heightened search for safety among investors.

Despite the near-term challenges, UBS maintains a long-term positive outlook for the EUR/USD pair, expecting it to recover as the Fed begins to cut rates. The firm anticipates that European economic growth will rebound next year, and as US growth eventually slows due to high yields, the two economies will converge, increasing demand for euros. Additionally, lower global yields should support risk-on currencies more broadly.

Investors should be prepared for the EUR/USD to test the lower end of the 1.05 to 1.10 range and potentially break below it. The weakened support around 1.05 is attributed to the delayed timing of the Fed’s first rate cut, now likely shifting to September.

InvestingPro Insights

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