Goldman: Large Drawdown As Tail Risks Re-emerge

Goldman Sachs note that “possible explanations for the worse-than-expected Euro performance include ongoing equity outflows from the region, wider sovereign spreads, and renewed investor focus on potential disruptions to energy prices from the war in Ukraine. Markets price an average of the full range of possible future outcomes, and there are admittedly several factors that skew near-term risks to EUR/USD to the downside - including the Russia-Ukraine conflict, but also the risks of even faster Fed rate hikes and pressure on global equities, as well as covid-related disruptions to China’s economy. The Euro will struggle as long as the perceived probability of these adverse scenarios is rising. But in the base case, where European energy supplies are not disrupted, the U.S. economy avoids recession, and Chinese macro policy becomes more stimulative, the Euro could rebound significantly. We are therefore marking down our EUR/USD forecasts, but sticking with an expectation for an eventual rebound on the back of ECB rate hikes. For the 12-mont horizon - currently representing Q223, when we expect the ECB’s policy rate to reach +0.5% - our revised EUR/USD target is $1.15, down from $1.20 (we also lower our 3- and 6-month targets to $1.05 and $1.10, from $1.10 and $1.13, respectively). We currently see a high-risk cross-asset backdrop with the possibility of further drawdowns in global equities and commodities. This will likely remain a challenging and volatile environment for the Euro.”