Weaker EUR/USD by the end of the year - BAML

Analysts at BofA Merrill Lynch believe that given what the market is pricing today for the Fed and the ECB and by how much the Euro has appreciated this year, the risks are asymmetric for a hawkish Fed surprise and a dovish ECB surprise this fall, leading to weaker EUR/USD by the end of the year.

Key Quotes

“We understand that this is a contrarian call, given the EUR/USD performance this year and particularly in recent weeks.  The good, the bad and the ugly scenarios Considering alternative scenarios and the implications for the USD:

• In a good scenario, US and global data improves and market euphoria continues. In this case, we would expect the Fed to continue normalizing policies, supporting the USD. Monetary policy divergence and risk-on should support USD/JPY in particular, but EUR/USD could also weaken. The USD could also do well against GBP if Brexit negotiations are slow—as we expect, despite a more pragmatic UK government after the elections this year.
• In a bad scenario, something triggers a sharp sell-off in risk assets. In this case, we would expect the Fed to slow policy normalization, but the ECB would still have to announce QE tapering. EUR/USD would likely appreciate, although not by much, as markets are already pricing a very slow Fed. USD/JPY would suffer the most, but we would expect the USD to still do well against high beta G10 currencies, such as AUD, CAD and NZD, and against EM. 
• In an ugly scenario, the sell-off in risk assets is much stronger, risking a global recession/crisis. We would expect in this scenario JPY and CHF, followed by USD and EUR to do well, against everything else. The EUR/USD implications would depend on the specific trigger and the details, and are hard to determine in advance.” 

“Therefore, we believe the USD would do well in most scenarios, although one would have to be selective depending on the scenario. The USD could do particularly well against high beta currencies and EM FX.” 

“All these scenarios also point to higher FX vol. This is easy to argue for the bad and ugly scenarios, starting from a point of low volatility. In the good case scenario, our expectation for higher vol is based on our thesis for Fed monetary policy normalization.”