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Goldman Slashes EURUSD Forecasts Further

Courtesy of ZeroHedge. View original post here.

Submitted by Tyler Durden.

In tonight’s data dump, in which Goldman has just slashed its forecast for the world economy and now sees a recession in France and Germany, among the actionable idea is the following update by forecast farce Thomas Stolper, whose batting average over the past 2 years is precisely 0.000 (go ahead, we dare you to calculate it). Instead of seeing a 1.40, 1.45 and 1.50 for 3, 6 and 12 months, the perpetually wrong Goldman FX team now expects 1.38, 1.42 and 1.48 in the EURUSD cross. From Stolper: “Given the latest global forecast revisions—and in particular the more marked downward revisions to our Euro-zone growth profile—we are shifting our EUR/$ forecast path slightly lower again and discuss potential additional downside risks. These changes follow a more substantial revision published in our latest Global FX Monthly Analyst. Despite these revisions, however, our strongest conviction remains that the underlying broad Dollar weakening trend remains intact. This is also reflected in the clear upward trajectory in our new EUR/$ forecasts of 1.38, 1.42 and 1.48 in 3, 6 and 12 months.” Based on the tried and true strategy of always doing the opposite of whatever Stolper recommends, if anyone needed a catalyst to long the EURUSD, this is it.

From the Goldman note:

A Further Downward Shift in our Upward Sloping EUR/$ Forecasts

As discussed in more detail in other research pieces published today, our growth forecasts have been revised lower globally, with some of the most pronounced revisions in Europe. A key reason for these changes are the dangers of a prolonged ‘muddling through’ scenario for the Euro-zone fiscal crisis, which is now part of our base-line forecasts. Slow political progress linked to the complex and mainly reactive decision-making process in the Euro-zone will likely remain a dominant feature in the foreseeable future.

This brings us further towards the centre of the distribution of possible outcomes than before. Although our bias remains skewed towards a belief that policymakers will ultimately make the right choices, the time-frame has become a lot longer. In this context, we have to give more weight to the negative feedback loop between slow political decision making, the resulting need for more frontloaded fiscal consolidation and the resulting slower growth.

Some of these concerns were behind the reason for our recent FX forecast changes published in the latest FX Monthly. We argued that the fiscal risk premium will likely remain higher on a permanent basis than previously thought. However we did not expect what now looks increasingly likely—a mild recession in the Euro-zone and rate cuts by the ECB, in addition to further credit measures to alleviate funding pressures in the periphery.

Symmetric Risk Scenarios

To summarise our new EUR/$ view, the two main building blocks remain a large and persistent fiscal policy risk premium in the EUR, and a strong and persistent downtrend in the USD.

Combining the two suggests we will still end up with a gradual drift higher in EUR, albeit on a downwardly revised trajectory.

The risks to this forecast are essentially symmetric.

Lower EUR/$: As discussed in a recent Global Markets Daily, the Italian debt situation is likely the biggest single risk for the Euro—and for the Euro-zone as a whole. The ECB is currently intervening in the Italian government bond markets to alleviate contagion pressures from Greece. Of course, the debt situation in Italy is quite different to that in Greece. The country already runs cyclically adjusted primary surpluses and on the latest IMF Fiscal Monitor projections, the debt level is expected to decline to only 114% of GDP by 2016. However, this is based on still slightly optimistic assumptions and in addition the projected improvements are likely not convincing enough to build market confidence.

Without further clear growth enhancing reforms in Italy, the ECB may well end up with unsustainable quantities of Italian Government debt on the balance sheet.

The second main EUR/$ downside scenario is continued growth weakness, beyond our new forecasts, and the resulting negative feedback loop of falling tax revenues and addition growth destroying fiscal tightening.

The third downside risk, though potentially related to the other ones, is continued broad weakness in cyclical assets. Given the persistently high negative correlation with the USD a negative growth shock would almost certainly boost the Dollar further and even more so if the shock originates outside the US.

Higher EUR/$. Most of the upside scenarios are linked to better policy implementation in Europe, including with regards to the use of the enhanced EFSF—for example, for a proactive bank recapitalisation. Via the unwinding of the existing speculative short positions in the market this could lead to a notable bounce in EUR/$, in particular when taking into account how low expectations are already.

A more hawkish ECB would likely lead to a stronger EUR also, although it is difficult to separate ECB tightening from a declining fiscal policy risk premium. More dovish surprises by the Fed would add to the upside risks for EUR/$.

Finally, generally improving risk sentiment on the back of better cyclical data would likely lead to a steeper EUR/$ trajectory than currently anticipate.


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