The euro has struggled over the past month as the U.S. dollar has regained its footing, but while the shared currency remains up on the year, investors should rethink their expectations that the shared currency will strengthened rebound against the buck soon, according to recent report from Bank of America Merrill Lynch.
There are at least eight reasons to start selling your euros EURUSD, -0.6292% right now, according to BAML currency, rates and emerging-markets strategist, David Woo.
1. Euro strength
The euro appreciated more than 14% in 2017, so much so that the European Central Bank grew concerned about its currency’s strength and possible repercussions. Meanwhile, German and French PMIs have weakened and manufacturing exports have declined. U.S. manufacturing, on the other hand, has picked up.
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“The contrast between a weak dollar-strong export orders and a strong euro-weak eurozone export orders leads us to think that the euro appreciation of the past year is beginning to bite,” Woo said.
2. Better U.S. growth
Foreign exchange trading always works in pairs, and one reason to ditch the shared European currency in favor of its U.S. rival is that growth in America has improved. Household spending in the U.S. is up, as is real disposable income. With the advent of corporate tax cuts, which lowered taxes for some individuals and corporations in the U.S. Woo also predicts that spending will increase further in the second quarter of the year.
Moreover, the higher rate of business investments should benefit both U.S. productivity and wages, making the growth story here to stay, according to Woo.
3. Lower political risk after Nafta
Canada, Mexico and the U.S. are widely expected to strike a deal in principle in May, ending renegotiations of the North American Free Trade Agreement, which began last year.
Even though an deal in principle would still leave months until the implementation, it should “help show the pragmatic side of the Trump administration’s pursuit of more favorable trade deals,” said Woo.
A successful agreement might even change the standing of the U.S. in trade negotiations with China and could change its calculations behind rejoining the Trans Pacific Partnership, suggested Woo. Trump has asked his top economic advisers to study the possibility of re-entering TPP negotiations.
Also see: Here’s what traders forget as headlines suggest imminent Nafta deal
4. Dollar repatriation
Ever since the talk of tax changes began, including its incentive for foreign-held assets to be repatriated, analysts have been trying to figure out how much money would get repatriated to the U.S. and push the dollar DXY, +0.54% higher in response.
BAML continues to think this positive backdrop will support the dollar. “Even though unlike in 2005 U.S. companies this time around do not face a deadline for bringing their offshore money home, a company that has decided to repatriate would have a very strong incentive to lock in the exchange rates right away,” Woo wrote.
5. Chinese capital outflows
“Capital outflows from China and reserve loss by the People’s Bank of China were a key if not the principal driver of general dollar appreciation in 2015,” said Woo. If this resumed, the dollar would see a boost.
To weaken interest-rate differentials between China and the rest of the world, which could inspire such outflows, the PBOC would have to raise rates in lockstep with the Fed. But continued deleveraging will make it difficult for the central bank to do so, Woo said.
6. Deficit risk premium
One of the risks investors see in the greenback, is the U.S. fiscal deficit, which along with the trade deficit, turns into the feared twin deficit. This is a general concern for investors and the dollar in the long term “since its reserve currency status is implicitly predicated on the assumption that Uncle Sam will always be able to pay its bills.”
But at this point, Woo said, this risk is priced into the dollar and doesn’t need additional risk premium.
“In our view, the market is too concerned about the fiscal implications of tax reform and has not given enough benefit of doubt to the possibility that tax reform will raise long-term growth potential. This is why the dollar will do well on positive growth surprises in this months and years ahead,” Woo said.
7. Supportive yield curve
“The flattening of the U.S. yield curve and the steepening of the eurozone yield curve are bullish for the dollar and bearish for the euro,” said Woo, adding that foreign investments in Treasurys are more likely to be currency unhedged compared with their eurozone equivalent, which should weigh on the euro-dollar pair.
8. Loss of euro momentum
The euro’s uptrend against its major rival has slowed, and while data from the Commodity Futures Trading Commission showed that those betting on further gains in the euro in the week ended April 24 declined, they still remain at an elevated level.
“History tells us that such divergence between momentum and positions is not sustainable,” said Woo, “especially given the negative carry associated with the trade.”
Unwinding euro longs, or bets of an advance against the buck, on a large scale would push the shared currency down significantly.