MUFG: Energy shock keeps euro under pressure

Analysts at Japanese financial giant MUFG maintain a short euro-dollar stance, arguing that the European currency faces a larger negative terms-of-trade shock from higher crude oil and natural gas prices.

Their scenario analysis links a 60% crude rise to the EURUSD currency pair around 1.1300, with ranges of 1.16-1.18 in a benign outcome and 1.0700-1.1300 under a more severe escalation.

“Based on our regression analysis and on how the dollar responds to a 10% jump in crude oil prices, the EURUSD drop of 3.0%-3.5% since the crisis began is consistent with the 50% advance from crude oil prices. Our analysis shows that for every 10% gain, the EURUSD drops 0.7%,” the MUFG analysts said.

“We continue to run a short EURUSD trade view based on the risk skew of further US dollar gains over the coming weeks.”

“In Scenario 1, we would see Brent crude in a range of $75-85 a barrel, which assume a risk premium of $10b is in the price for some time. The US dollar could weaken back modestly with EURUSD in a 1.16-1.18 range.”

“A crude oil price of $110/b would be a near 60% increase from the pre-conflict level which, based on our regression analysis, would imply the EURUSD pair falling to 1.1300 – so we assume a Scenario 2 range of 1.1200-1.1600. De-escalation ultimately takes place, it just takes longer to achieve than in Scenario 1.”

The MUFG analysts added that with a 100% increase in crude oil prices and more in natural gas prices in Europe, the dollar gains further with scope for EURUSD to drop as low as 1.0700. The EURUSD range is 1.0700-1.1300.

“However, the increasingly hawkish repricing of ECB policy expectations is unlikely to prevent further EUR weakness, given the bigger negative terms of trade shock facing European economies from more expensive energy imports. EURUSD has now broken below support at 1.1500, reinforcing our short EURUSD trade idea.”

(Source: OANDA)