Fundamental Forecast for EUR/USD: Neutral

– EUR/USD losing ground in May falls in line with twenty year seasonality trends.

– The retail crowd remains net-short EUR/USD but shifting rapidly – see live SSI updates.

– Check in on the EUR/USD quarterly forecast, “EUR/USD Stuck in No Man’s Land’s Headed into Q2’16 – Don’t Discount ‘Brexit’”

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The Euro took a small step back last week, with EUR/USD losing ground especially quickly over the last two days of the week as US economic data started to turn in a bit better than expected. Yet even as economic data for the Euro has picked up in recent weeks – the Citi Economic Surprise Index has improved from -25.3 on April 15 to -7.4 on May 13 – the overhang of the weak growth environment is proving considerable (as evidenced by the mixed-to-disappointing Q1’16 Euro-Zone GDP data release on Friday).

The last two weeks of declines in EUR/USD have come despite inflation expectations edging up alongside energy prices. The 5-year, 5-year inflation swap forwards, a market measure of inflation expectations, has increased from 1.402% on April 15 to 1.478% on May 13. After the European Central Bank adjusted their forecasts in their staff economic projections at the March meeting, Brent Oil is approximately +40% (relative to the front month and December 2016 contracts) above the ECB’s 2016 technical assumption as of market close on Friday.

Chart 1: EUR/USD Spot versus ECB’s EUR/USD NEER (November 16, 2015 to May 13, 2016)

As the ECB had previously declared that they were no longer targeting the FX channel, the Euro had been given some breathing room to rally against its peers. But it’s fallen back, and after the March adjustments to the forecasts, EUR/USD is now only +1.88% above the ECB’s 2016 technical assumption of $1.1100 (it was +3.91% above on May 2) (chart 1 above). Put plainly, with energy prices edging up, the Euro is becoming less of an issue for the ECB.