FX Talking: Waiting for the European phoenix

The first quarter of 2021 will not be remembered as the finest hours of European politics. The glacial rollout of vaccination programmes and the ‘crown jewel’ of the EU’s fiscal stimulus – the EU’s €750bn Recovery Fund – gathering dust in a Karlsruhe courtroom stand in stark contrast to the achievements in the US.

Yet all is not lost. European manufacturing is holding up well and there are signs of life in the EU vaccine rollout. Our EUR/USD profile is slightly dimmed, but we still expect the euro to rise from the ashes of European policy. It should be in a position to challenge 1.25 – though probably not now until the third quarter. This all assumes that the Federal Reserve can withstand the coming tide of inflation and that US 10-year yields can move to 2.00% in an orderly manner.

Having not abandoned a call for the euro to rally, CE4 currencies should strengthen through the year led by the Czech koruna and then the Polish zloty. Hungary's forint should underperform in 2Q as real rates turn more negative. EMEA high yielders face a more difficult time, although we suspect a lot of the bad news (a fresh round of US sanctions) may be already in the rouble. 

A delayed, but not derailed global recovery should continue to support the commodity bloc, where both Norway's krone and Canada's dollar are backed by central banks at the front of the queue when it comes to policy normalisation.

We also think the Mexican peso can outperform, helped in part by some of the US stimulus finding its way to Mexico via remittances.

Elsewhere, the dollar bounce in 1Q has set back the Asian FX rally and the story is certainly more mixed now. China's yuan and the Korean won can still advance, yet semiconductor challenges may well be doing some lasting damage to the Taiwan dollar's long-term prospects.