Euro: Rate support at risk against US Dollar with energy shock – ING

ING’s Francesco Pesole argues that the EUR/USD short-term rate differential is currently supporting the Euro as Gulf tensions rise, helped by a recovery in EUR front-end rates. However, he doubts this can last if Oil and Gas prices keep climbing, given limited scope for more ECB hikes and worsening eurozone terms of trade. ING warns that EUR/USD could risk a move toward 1.10 under higher energy prices.

Euro buoyed by rates for now

"The EUR:USD short-term rate differential is – for now – helping to keep EUR/USD afloat in this Gulf re-escalation. The two-year swap rate gap has re-tightened around 15bp since the start of July, primarily because the rebound in oil prices happened at a time when ECB hike bets were dwindling, leaving more upside room to recover for EUR front-end rates."

"We aren’t convinced this rate gap can offer sustainable support to EUR/USD if energy prices continue to rise though."

"Markets may find it harder to price in more than two ECB hikes by year-end (now, 46bp) considering the less hawkish stance by ECB officials of late, and the medium-term negative implications of an energy crisis – combined with Fed tightening – for the EUR, tend to outweigh the positive of EUR hikes."

"The spike in gas prices is particularly concerning, as it weighs on the eurozone’s terms of trade more than oil."

"In a scenario where Brent returns to $90-100/bl and TTF around €55-60/MWh, a move to 1.10 becomes a tangible risk in EUR/USD."