EUR: Breakup premium set to widen further – RBC CM

Adam Cole, Research Analyst at RBC Capital Markets, suggests that in the immediate wake of the UK referendum, the EUR risk premium widened to 17¢ - a relatively small move that suggests much of the fall in EUR from 1.14 to 1.11 on Friday was USD strength, not independent EUR weakness.

Key Quotes

“A useful way to look at EUR’s independent direction into and after the UK referendum is what we previously called our EUR risk premium. Recall that our EUR risk premium is a measure of independent EUR direction based on the deviation of actual EUR/USD from a synthetic EUR.

Following the UK referendum and the ongoing uncertainty it has created, it is not unreasonable to think the risk premium carried by EUR will widen materially further from here, even if the ECB's ring-fences mean it never gets back to the peak level of the crisis.

A series of domestic events in the Eurozone can only add to this pressure going forward. Beyond this weekend’s elections in Spain, both France and the Netherlands hold elections in H1 2017 (April/May and no later than 15 March respectively). Both have far right movements supporting a referendum (and exit). Anti-EU Geert Wilders is leading the polls in the Netherlands. Italy holds its own referendum on constitutional law in October, where the 5 star movement (in opposition) also favours a referendum.

In the near-term, a continuation of the trend in 2016 H1 would imply a 5-10c further widening of the risk premium through H2, which we think is a reasonable working assumption, though the pace of widening is more likely to accelerate than decelerate. Other things being equal, this would take EUR/USD to a 1.00-1.05 range.”