Only 2-3% gains likely in euro now: Expert

The euro has hit a new high for the year against the dollar backed by macro strength and weak US jobs growth. However, the currency is likely to rise only 2-3 percent further, says Sebastien Galy, FX Strategist, Societe Generale.

Speaking to CNBC-TV18, Galy says yields in Europe are now likely to fall.

“It is a great fixing on trade. It is very painful economic trade and unfortunately we will see that outcome coming out in the next few weeks or probably month,” he adds.

Below is the edited transcript of Galy's interview to CNBC-TV18.

Q: What do you make of this rise that we have in the euro in the last couple of trading sessions and whether you think it is likely to surpass its yearly highs for this year?

A: The rise in euro in the past sessions is completely opposite to what happened two years ago, which is that everybody was extremely bearish on the euro. Right now, people are moving out of the dollar and are trying to find yield in euro land and consequences are seen that euro dollar trending very sharply higher. It has been reinforced by a weaker data coming out of the US, expectations of the Fed will taper a little bit later than it is expected and unfortunately it means for European economies and we had some first signs coming out that will hit the exports.

The problem is a currency can move a lot before it hits the real side of the economy and one of the reasons is hedging strategies, which are typically done on a quarterly basis up to a year. That means the minimum amount of time it takes for a currency to rise and its impact on the economy is about three months and unfortunately for euro land it is a little bit also in the recovery cycle and the outcome of that is that the European Central Bank (ECB) may misjudge the signal

The euro dollar’s fair value from a long-term point of view, which is marginally above it but it is trading in a very expensive fashion if you consider that there is still lot of pluming issues in euro land, actually its trading, what we could consider 95-97 percent quanta, means is only 2-3 percent chance of going higher than it is.

The problem is market doesn’t seem to care. It is looking at the euro zone opposite to the dollar and the consequences unfortunately, is lot of pain down the road in euro land, it means that the yields in Europe are going to go in a lower particularly in the core making very easy conditions for the different actors on the government side, which is a good news. So, it’s a great fixing on trade. It is very painful economic trade and unfortunately we will see that outcome coming out in the next few weeks or probably month.

Q: You are saying that the chances of the euro appreciating from hereon are slim. Are you saying that means that the delayed taper has been fully priced in to the dollar at this point?

A: To be precise the euro-dollar has been price for perfection for long-term as it rises so actually continues to overshoot and it may continue to overshoot and the reason is not the euro land where it’s actually overpricing the quality of the credit in Europe, which is a good news. There is anticipation that there will be more tightening of credit in Europe but the currency is overshooting that signal.

If you look on the other side of the equation, not the euro side but the dollar side, the Fx market is pricing in a bad data coming out of the US but not very bad and, consequently a delay in Fed tapering. This what you can see also in US treasury curve.

There has been an expectation that the Fed will tighten must latest, people were talking including ourselves about September, now other people are talking about March and we are moving on that side of the equation on dollar, moving from a strong dollar story, which created a gigantic amount of panic in emerging markets

On the other side of the equation it is exactly the opposite which is that the Fed will hold for a lot longer than expected and the euro dollar is unfortunately trading not too much as a function of credit in Europe though that is still in helping but it has been suffering from expectations of what the Fed will particularly under Yellen who is known as a rational dove in the sense that she will rationally be dovish because she has good reasons to do; labour market remains relatively not strong enough if not to say weak

She need not to print money necessarily but to keep yields as low as possible for as long as possible in the US and European as well as emerging markets will suffer from that kind of policy and it might be painful in Europe, it will be little more painful in some emerging markets.