RBS on top with short-term euro resilience bet

Royal Bank of Scotland (RBS) has topped this week's one-month currency forecast rankings after betting that the euro would hold ground against the US dollar, particularly as the markets begin to factor in the potential effects of the upcoming US presidential elections.

Aiming slightly higher than the contributors' consensus view of 1.25, RBS accurately predicted on June 1 that EUR/USD would rise from 1.23 to 1.26 in a month's time as part of a gradual climb towards 1.30 over several months.

"Our forecasts were based on the idea that positions had gotten extremely stretched, and we were concerned there wasn't going to be enough bad news through June in terms of data and the European Union policy response for the euro to maintain its downward path," says Paul Robson, senior foreign exchange strategist at RBS in London. "We also considered the extent to which European Central Bank easing had already been priced in, and we were looking for a small squeeze of positions that would see eurodollar move up to 1.30 in the months ahead."

Moving into the second half of 2012, Robson believes the US dollar is set to steal some of the attention currently focused on the euro, as the market positions itself for the outcome of the US elections and the impact on the country's monetary policy.

"We still maintain that the euro will trade weakly in the quarters ahead, but it's not all about the euro, and increasingly in the second half of the year it could easily be about the US dollar's own fiscal problems. We think eurodollar will move just a little bit higher going into the US election, and we worry about the degree to which fiscal policy will need to be tightened and what that might mean for the US Federal Reserve's monetary policy stance," says Robson.

It's clear that the rating agencies and the market have at times become worried about political mandates that don't allow for strong fiscal policy

The prospect of political instability in the US following the presidential elections – or of aggressive fiscal policy post-election leading to further quantitative easing – provides too much room for speculation, to the detriment of the dollar, Robson adds. While he does not expect this to lead to significant upside for the euro, he believes it is enough to suggest it won't drop dramatically over the next few months.

"Over the past couple of years the markets have treated weak political backdrops very harshly. It's clear that the rating agencies and the market have at times become worried about political mandates that don't allow for strong fiscal policy. At a time when budget deficits are very large, clearly sovereign risks are in the forefront of people's minds," Robson explains.