We construct a short-term flow model for EUR/USD and illustrate the key role by both portfolio and speculative flows in tracking the cross in recent years.
The model suggests that equity flows and speculative positioning have been key in driving EUR/USD lately. These flows may settle somewhat near term however, making for a period of range-trading in the cross.
Further out, we expect EUR-positive flows to resume as pricing of an ECB exit resumes, which should take EUR/USD firmly above 1.20 in 12M.
A 'normalisation' in relative rates and in euro-area portfolio and speculative flows has the potential to send EUR/USD towards 1.30 as the ECB phases out unconventional measures.
We advise clients with USD income/assets to hedge using longer-dated forwards whereas expenses should be hedged with knock-in forwards. Clients with a speculative mandate should look for opportunities to go long EUR/USD.
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