In our view, the past two weeks' repricing of the EUR/USD FX forward curve is premature.
We look for EUR/USD FX forwards to grind higher over the coming year as the Fed still has four more hikes to go and is set on continuing QT well into 2019.
Hence, we still see value for EUR- (and DKK-) based investors in hedging USD assets further out the curve, i.e. out to 12-15M.
A range of factors driving EUR/USD FX forwards
During the past two weeks, we have seen a repricing of the EUR/USD FX forward curve. Across the curve, FX forwards have dropped back. A set of factors has played a role in this development. (1) The premium on EUR/USD FX forwards over year-end has declined; (2) in general, we have seen a narrowing of the EURUSD OIS basis; and (3) following the equity market sell-off, 1-2Y USD OIS swap rates have declined (see Chart 1).
We stick to our previously held view, i.e. that we look for the Fed to hike policy rates in December (likely a 20bp adjustment hike of interest on excess reserves) and three times next year. We still think the risk is for EUR/USD FX forwards over year-end to rise further from current levels and in general, the continued tightening of USD liquidity (see Chart 1) will continue to put widening pressure on the EURUSD OIS basis.
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