While the fears of a recession in the US that temporarily prevailed on the market are increasingly proving to be exaggerated, the economic outlook for the euro zone has become considerably cloudier, according to Thu Lan Nguyen, analyst at Commerzbank. For this reason investors are again betting on more divergence between the Fed and ECB’s monetary policies and therefore on an elevated “crash risk” in EUR/USD. Key Quotes “The recent improvement in economic data and a somewhat stronger inflation pressure have for now dispelled the fears of a recession in the US that had temporarily dominated the markets. Also, inflation expectations have moved away from their lows, and the trade-weighted exchange rate of the USD has stabilised. Since today’s employment report should also turn out rather positive, it is likely that investors will increasingly bet on rate hikes by the Fed, which should provide tailwinds for the USD.” “In contrast, prospects for growth in the euro zone have deteriorated considerably. Weak economic indicators and the decline in the euro zone inflation rate have made it more likely that the ECB will decide a comprehensive package of measures next Thursday. An elevated “crash risk” in EUR-USD is therefore being priced on the option market.” “Further developments in the EUR exchange rates will eventually depend on the specific expansionary measures which the ECB takes at its upcoming meeting. A reduction of the deposit rate alone would be unlikely to weigh on the EUR, even if it turned out larger than currently anticipated on the market. In this case investors would probably speculate that the ECB has virtually reached the lower bound in interest rates, which means that further rate cuts would be unlikely. But if the ECB at the same time introduces a tiered interest rate or completely exempts a part of excess reserves from the negative interest rate, like the Swiss and Japanese central banks have done, the EUR should come under stronger pressure, as the ECB would thereby reduce the burden on banks and attain greater leeway for further rate cuts. The ECB could thus credibly threaten further rate moves and in this way weaken the EUR on a sustainable basis.” For more information, read our latest forex news.