Views on EUR/USD

I haven’t read any bank research in a long while, but I thought it might be interesting to see what the street had to say about the recent break through 1.50. My quick thoughts are in italics:

UBS – With the EURUSD break of 1.50, we are not tempted to fade this latest US dollar move. The decoupling theory is proving true so far in Europe, with the German Ifo index surprising on the upside, helping Eurozone 2-year yields rise by 5bp. In contrast, the slump in consumer confidence in the US pushed US 2-year yields lower by 11bp. Consequently, the latest bout of weakness in the US dollar has been all about yield differentials and relative growth expectations, coupled with a clearing out of consensus positive dollar views. If the dollar longs have been cleared out, is it time to start building a short position?

ABN technical analysis – The strong and vicious break above the major barrier around 1.4863 has cleared the way to the major price projections on the daily and weekly charts. This projection range starts at roughly 1.5100 (weekly) and 1.5190 (daily). Short-term momentum is sky-high but not overextended. The RSI is overbought (86) but since the market is engaged in a breakout move, not too much value should be given to this indicator. Buy the dips when they occur. Dipping below 1.4860 will shake the bullish outlook.  Sky high, but not overextended?

ABN fundamental analysis – The DXY index has fallen to 74.46, also a record low. In addition to the fresh widening in interest rate differentials, one of the key drivers of this move appears to be the surge of oil prices above the $101 level as petro-dollars are channelled into the EUR. Dovish comments by Fed’s Kohn also added impetus to the USD’s decline. Kohn noted that growth risks are a bigger threat than inflation which has led the market to look for another 50bp rate cut in March or possibly sooner. Or is it that are oil prices responding to the weaker dollar?

SEB macroeconomics – Although the US dollar is close to extreme undervalued levels against the euro this is not the case when looking at the trade weighted US dollar which has become only slightly cheap compared with our PPP estimate (lower chart). The upshot is that should the weak US dollar be seen as an independent problem by a central bank, for example the ECB, currency intervention is unlikely to work.

As long as the US dollar is not dirt cheap in trade-weighted terms, central bank intervention to dampen appreciation is unlikely to be fruitful. The one instrument that would work is lower policy rates. The EUR/USD thus carries upside risk as long as this is not deemed an option by the ECB. A higher euro protects the euro area economy against the escalating oil price, but exporters will be hurting and the argument can be made that the euro is unfairly shouldering the burden of dollar depreciation, as much of the world continues to retain artificially low currencies. The ECB has to weight the pros and the cons but I believe the risk of talk of concerted action has risen substantially.

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2 responses to “Views on EUR/USD

  1. C, the retail market is still net short EURUSD, if you can believe it. I wish I could trade this move, but I promised myself that I would not trade for the remainder of this week or the next. Alas, I cannot be a part of history — even though the markets memory of that history is often shorter than a gnat’s attention span…presuming I know what the span of a gnat’s attention is…

    My personal opinion is that the pundits are right about 1.55. My personal opinion about my personal opinion is that I will not leverage that knowledge and instead trade my plan. Alas (again), I have no plan for the remainder of this week or the next.

    I trade on hourlies primarily, so if I did have a plan, it would be to trade on pullbacks in the direction of the prevailing trend — but again this depends on the time horizon. I suspect yours is longer than mine (which is closer to the gnat’s). I think there are a couple of things I’m worried about — hints the FED will not raise in March and hints the ECB will be forced to take action to protect their exporters, despite the projected rise in oil (and other commodities).

    The good news is that I think the credit problem has just about completely uncoiled. We may see another leg down in major equities markets, but I also think the panic is over and liquidity will again return — albeit incrementally. I disagree that growth risks are bigger than inflation risks. (Kohn’s comments.) Or, rather, I am more persuaded by the arguments of those who disagree with Kohn.

    I think that the process of channelling petrodollars into Euros is junst another way to say oil prices reacting to the weaker dollar. They are two faces of the same multifaceted die. As petrodollars are channelled into increasingly into Euros by Gulf states (who are rightly concerned about the value of their cash reserves), this puts systemic pressure on the value of the USD. (Right?…tell me if I’m wrong here.) We may even see further “depegging” in this region and possible a concerted move to a basket approach. (Good trading opportunities there!)

    We heard talk of concerted effort back when the EURUSD was at 1.3. I recall the EU making most of the noise, while the US seemed almost bipolar — talking about the depreciation of the dollar but in fact pursuing a USD-depreciating strategy. Now I think we are approaching the “uncle” point, where both the ECB and the Fed (not to mention other central banks) begin to consider that current values are not facilitating the common objectives (such as they are) of the G7.

    The funny thing is that central bank intervention could still work if a host of other factors are correctly aligned. The problem is one never knows until after the fact — and the lag time seems much longer due to the hypersensitive market environment. This means more volatility in the months ahead, which means good trading opportunities!

    Just some ramblings because I am not allowed to trade right now…I’m sure I’ve made some errors in my thinking, but this is a blog afterall. (Right?…)

    Cheers

  2. Interesting thoughts LT – I agree with the reasoning that the euro should be higher on fundamental grounds, but because this argument is so compelling when contrasted with the US, I am reluctant to take this position. It’s the old problem of what to do when everything is in the price. Wrt positioning, I don’t believe the available information is telling us anything of practical use here, and I remain on the sidelines…like you, I won’t hold a long-term position here. However, if USD/JPY or USD/CHF crack 100 or 1.00 respectively, I may look to lining up some small longs (although I’d probably be too scared to carry out any trades).

    ps – Intervention risk is a potentially beautiful trade from the long USD, im(worthless)o. I’m thinking there is no mention of it at these levels, but as soon as talk does start we could see a strong USD rally. It’s a kind of free option for the long usd traders, if there are any out there….in the wildnerness.

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