In view of Jane Foley, Senior FX Strategist at Rabobank, it surprising that Merkel yesterday described the EUR as “too weak”, even though there is plenty of evidence to support her claim.
“It was perhaps because Merkel was speaking to school children yesterday that she was drawn into an explanation of how a currency impacts trade flows. During the Eurozone crisis Germany suffered heavy criticism for maintaining a solid trade surplus while other countries in the region were suffering deep recessions. More recently President Trump has also pointed his finger at the German trade surplus. While Berlin has pushed back by claiming that it cannot be blamed for maintaining a strong competitive position, Germany has been operating with an undervalued exchange rate for years.”
“According to the OECD’s estimate for Purchasing Power Parity, fair value for EUR/USD stands at 1.34, making the EUR currently 18.9% undervalued vs the USD. Not all estimates for fair value are as extreme, but several suggest that the EUR is cheap relative to the USD. When Germany’s effective exchange rate is considered, this indicates that German exporters are operating with a considerable advantage relative to other countries within the Eurozone.”
“The cheapness of Germany’s effective exchange rate offers support to the view that monetary policy settings may be loose for the German economy. Although Merkel’s comments about the “too weak” haven’t created this backdrop, they have brought attention to it at a time with the attractiveness of the EUR is already being boosted by an improved political backdrop in the region. Also bolstering the relative attraction of the EUR has been the coincident souring of reflationary hopes and political coherence in the US.”
“EUR/USD has already taken out our 12 month target of 1.12. This morning, solid German economic data releases suggest further near-term upside potential for the EUR. However, we warn that the direction for EUR/USD is unlikely to be one–way. The dollar index is currently technically oversold and EUR/USD is overbought. Meanwhile, Fed officials such as Kaplan have recently reiterated the risks associated with further Fed tightening this year while there is also the chance that ECB Draghi could restate his dovish tone at the June 8 policy meeting. Consequently, we see risk of pull backs in EUR/USD over the next few weeks. Resistance at the September 2016 high at EUR/USD1.1280 area ahead of the August 2016 high near 1.1366.”