UBS: Why now may be the time to go long the euro

US dollar is a relative trade: Analyst

The euro may have taken a beating from a combination of a strong dollar and fears over Europe's political future, but now is the time to go long, a UBS analyst told CNBC on Thursday.

The euro has tumbled against the dollar in the wake of Donald Trump's surprise election as U.S. president, falling as low as $1.0339 this month, from levels above $1.11 in early November. The , which measures the greenback against a basket of currencies, surged to a 14-year high after the election on hopes for fiscal stimulus and greater inflation. On Thursday at 1:52 p.m. HK/SIN, was fetching $1.0752.

Tan Teck Leng, a foreign-exchange analyst at UBS, told CNBC's "Street Signs" on Thursday, that he expected the euro would rise to $1.20 on a 12-month basis.

"I think there is a big mispricing on the euro-dollar right now because the market is actually happily still using the euro as a funding currency for now because Draghi is extremely dovish," Tan said.

Last week, European Central Bank (ECB) President Mario Draghi said rising inflation on the continent hadn't yet shown a convincing trend for the central bank to change course.

At its December meeting, the ECB had said it would extend its generous bond-buying program at a reduced pace of purchases of 60 billion euros ($64.46 billion) a month from April, down from 80 billion euros.

But Tan expected that once the French elections in May were past, Draghi "has the ability to be a lot more hawkish."

Tan pointed to medium-term inflation expectations, which had risen to 1.7 percent, not too far from the ECB's 2 percent target.

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"By the middle of this year, once the medium-term inflation expectation touches its target of 2 percent, we actually can expect a strong hint that he can reduce the program a lot more," Tan said.

He added that the political risk over upcoming European elections was offering investors a "decent discount" on the euro.

"There is a political premium right now on the euro and in fact, we don't think there will be big accident out of those events. So right now the price on the euro, you are getting a good discount," Tan said.

To be sure, the political calendar in 2017 is quite full. The Netherlands has its general election on March 15. France chooses its next president in May and Germany will vote for the country's chancellery after the summer. Italy was also set for fresh general elections, though the date hasn't been confirmed yet. Meanwhile, the European Union (EU) will be tackling two thorny issues: the U.K.'s Brexit and making sure Greece sticks to the terms of its rescue.

Tan pointed to another factor that had been weighing the euro: The dollar's rise on expectations the Trump administration would pursue fiscal stimulus.

"Initially, the markets were buying dollar based on expectations of the amount of fiscal stimulus that Trump would introduce and they were shorting currencies like the euro," he said. "That divergence has actually gone a bit too far. That is a relative trade and actually people are now paring back on expectations," he added, noting that the U.S. fiscal boost might not materialize until 2018, not this year.

That has meant that expectations the U.S. Federal Reserve might increase interest rates three times this year could be "overblown," Tan said, adding that UBS expected only two hikes this year.

He expected market disappointment would weigh on the dollar.

—Silvia Amaro and Sam Meredith contributed to this article.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1

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