UBS presents 3 scenarios that could lead to a decline By Investing.com

The euro (EUR) has remained in a tight trading range against the US dollar (USD) throughout most of 2023, with UBS analysts expecting this trend to continue throughout 2024.

According to UBS, the combination of political, economic and market dynamics makes forecasting the exchange rate particularly difficult. Key factors influencing these expectations include the outcome of the French election, the UK’s economic policies under its new administration, and upcoming US economic data releases.

The impact of the French elections

The recent French elections had a major impact on the EUR/USD outlook. The elections resulted in a hung parliament, with President Emmanuel Macron’s centrist group performing better than expected.

The far-right National Rally party suffered a major defeat, coming in third behind Macron’s left-wing and centrist New Popular Ecological and Social Union (NUPES) coalition.

UBS analysts noted that the election results remove the immediate risk of a conflict between the next French government and the European Union. With the far-right National League party’s proposals ruled out, the potential for euro volatility due to political uncertainty in France has diminished.

However, the composition of the new government and its policy orientations remain unclear, which could impact the performance of the euro in the medium term.

Despite the election results being less disruptive than expected, UBS is keeping its longer-term target for EUR/USD at 1.0500. Analysts argue that while the French political outcome is not a worst-case scenario, it is not particularly favorable for the euro either.

But Macron’s focus on domestic politics could limit his ability to push for further EU integration, which could hurt the euro.

EUR/USD bearish scenarios

UBS has identified three scenarios that could lead to a larger decline in the EUR/USD pair compared to current expectations.

In the first case, UBS said that if the new left-dominated French government actively reverses key reforms such as raising the retirement age, it could create market uncertainty and pressure the euro.

Second, the stalemate in the French government could create a sense of instability, which would affect investor confidence and the euro.

Last but not least, upcoming French economic data, including preliminary PMI, business confidence, and consumer confidence, could show signs of weakness due to political uncertainty. UBS said that weak economic performance would make it difficult for France to meet its budget targets, weighing on the euro.

Despite the challenges, UBS maintained its target for the EUR/USD pair at 1.0500, with possible deviations depending on future political and economic developments.

Meanwhile, a potential shift in the Democratic ticket is expected to keep markets in a state of activity, which could lead to increased volatility.

However, with no specific deadline or timetable for changes other than the Democratic convention on August 19-22, pricing risk premiums on this issue remains difficult.

UBS analysts see the upcoming elections as a catalyst for higher implied and realized volatility in the latter half of the year.

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