Euro Strength; Financial Flows will Trump Rate Differentials

It’s 2004-06 all over again, writes George Saravelos from Deutsche Bank in a report published last week. The Fed is hiking rates, US rate differentials are widening and the dollar has become a G10 high-yielder. This has been extremely $-positive in the past yet the dollar is not responding. Why? Saravelos suggests that current dynamics look very similar to the 2004-06 Fed cycle, where the dollar weakened even as the dollar became one of the highest-yielding currencies in the world. Back then, the dollar’s vulnerability was a sharp deterioration in the current account: weaker flows mattered more than rates. It could be the same again in 2018, he argues, but this time on the financial side. He forecast the euro to trade as high as 1.30 in 2018.