Fed Near Neutral Signals Caution Ahead, Shifting Focus to Fixed Income in 2026 
Since mid-January 2015, EURUSD has been trading in a 1.04-1.16 range, averaging around 1.11. Real rates matter: Over the same period, the US/German 10y real yield differential has been in a 70-160bp range, and European investors, crowded out of domestic bond markets by ECB purchases, have been buying large sums of foreign bonds.
Given that real yield differentials are unlikely to widen much further as US inflation expectations remain elevated, and given that the ECB is likely to slow the pace of its bond-buying programme at some point in 2017, we see a significant probability that we will also see a turn in the euro’s trend against the dollar sometime next year.
However, that turning point has been postponed (and the euro’s trough lowered) by a surge in concerns about the political outlook in Europe after the surprise outcomes of the UK referendum on EU membership and the US presidential election.
The year of European politics. Front National candidate Marine Le Pen seems very likely to make it to the second round of France’s presidential elections on 7 May 2017, but she is unlikely to prevail in a two-candidate showdown. The tailwind behind populist and anti-establishment politicians, however, is likely to scare buyers away from the euro until after the election, unless opinion polls show a very clear outcome.
On that basis, despite the strong economic case for the euro to start bottoming out earlier, we expect to see EURUSD reach parity in H1, and to rise on gradually in H2. However, a stronger move is possible in 2018, after the German and Italian elections.
Euro beats yen. EURCHF and EURGBP trends are likely to mirror EURUSD (down, then up), but EURJPY can maintain its steady rise as JGB yields remain (relatively) capped. That said, we expect the euro to underperform the Norwegian krone and Swedish krona through 2017.
But the political risks are clouded in euro area. Polls scheduled in Germany, France and the Netherlands. The euro area economy has so far weathered political surprises in the form of the UK’s referendum vote to leave the EU and the election of Donald Trump as the next US President.
Euro area political indecisions would now be prevalent over the coming year, with key elections taking place in –
The Netherlands (15 March),
France (first round of the presidential election on 23 April and second round, if necessary, on 7 May) and
Germany (by 22 October).
Latest polls advise that the far-right Freedom Party may win the most seats in the Netherlands, although without a majority.
In France, the far-right candidate Le Pen is expected by commentators to make it to, but not win, the second round. An unexpected victory for Le Pen would call into question the EU project.
In Germany, the Chancellor Merkel, is expected victory for a fourth term, although the right-wing AfD party is a key wildcard.
