Currency markets have been in limbo for the better part of 2017 following the December 2016 post-U.S. election rally in the U.S. Dollar. After reaching a 13-year low against the dollar in early January, the euro has held above parity as financial markets wait for the next move. Bank of America analysts see more strength in the greenback in the first part of 2017, which will put further pressure on the euro. "It is all about the USD and about President Trump's policies for the EUR for now," Bank of America Merrill Lynch wrote in a research note.
"We remain constructive on the USD, expecting the policies of the new US administration to focus more on fiscal stimulus and deregulation and less on trade protection. This explains our bearish EURUSD projections for H1."
Short-Term Political Concerns
Adding to short-term European concerns is political uncertainty. The Netherlands general election is on March 15th, and current polling has the anti-EU, populist party lead by Geert Wilders ahead. A win for the anti-establishment party would further threaten the stability of the European Union. (See also: The European Banking Crisis Explained.)
One month later, the French people head to the polls where far-right candidate Marine Le Pen has threatened to shake the system if elected. She has vowed to leave the EU and pull out of the euro if elected. Despite Le Pen polling well behind in the presidential race, BofA says investors should not remain complacent. "Having been wrong on the UK referendum and the U.S. elections, investors are now hedging French election risks. This flags downside EUR risks ahead of the French elections," Bank of America ML wrote in a research note. (See also: Should Investors Worry about Marine Le Pen?)
Improving Economic Data
Despite the geopolitical uncertainty, improving economic data from the Eurozone will push the euro higher into the end of 2017, BofA said. Economic sentiment and data are trending upwards, and while inflation remains below the European Central Bank (ECB)'s 2 percent target, last month's 1.8 percent reading was the fifth consecutive monthly rise and the highest level in four years. "The macro data in the Eurozone is on an upward trend. Data surprises compared with the consensus have been positive since September 2016," Bank of America wrote.
The Bottom Line
With a busy first half of the year on the political calendar in Europe, BofA believes the EUR will remain under pressure. With possible wins for anti-EU candidates in the Netherlands and France they have a target of 1.02 against the dollar by mid-2017. However, once the political uncertainty subsides, they believe the EUR - currently 7 percent below its long-term average, to trade back to 1.05 by the end of 2017 and 1.10 in 2018.