The Euro and the Risk of a Squeeze

The speed of the euro’s decline is starting to put seasoned market-watchers on edge.

Monday, the currency hit another 12-year low, an almost daily occurrence right now, with the rate touching $ 1.0457.

This is marvelous news for the funds that have bet on a slide.

But with the euro now down by almost 13% against the dollar so far this year and counting, it’s all happening very quickly. Many analysts had penciled in $ 1.05-ish for the end of this year. Now they’re scrambling for ‘more bearish than thou’ forecasts under parity.

As a general rule, major currencies just don’t move as sharply as this. Emerging-markets currencies sometimes, but not the big tectonic plates like the euro.

“We are now at one of those tricky points where on the one hand, our view has been fundamentally very euro-bearish. But on the other hand, prices have moved very far very fast, and we have already reached our trading targets,” says Jens Nordvig, head of currency strategy at Nomura.

While expectations that the currency will keep sliding in the medium term remain intact, he says, “from a trading perspective […] the risk of a significant retracement higher to 1.10-1.12 for EUR/USD is also increasing.”

The bank, which was short the euro against the dollar, is closing the trade after making a profit of 5.9% as the euro kept falling and is now using different options that allow to trade at the same time both a possible fall and a temporary bounce back in the currency.

Positioning data confirm this view is shared among investors. With the euro trading at its weakest levels in 12 years, combined bets that the euro is going to fall are now lower than the record shorts hit earlier this year, after the ECB announced its easing program, as shown the gray area in this chart.

And it’s certainly not too hard to imagine that the Fed this week disappoints those looking for a rate rise sooner rather than later. If Janet Yellen stays patient, the dollar would be very vulnerable to a tumble.

Henderson Global Investors is among the investors closing bets on the euro seeing the fall in the currency so far this year as sufficient.

The asset manager closed a euro short trade at the end of last week. “The euro has weakened a huge amount already and the move has become quite parabolic and pretty consensus,” says Kevin Adams, head of fixed income at the firm.

But weekly positioning data from the Commodity Futures Trading Commission Friday show that investors have bet a combined $ 24.2 billion on a further fall in the euro against the dollar as of March 10.

These numbers represent a little sliver of the market, but are still a decent read on speculative bets as a whole. Bets against the euro have been building since mid-2014.

At first flush, this all seems odd in the context of climbing stocks. So far this year, the Stoxx 600 European equity index is up by about 17%. The Dax 30 has become one of the world’s best performing indexes, and on Monday surged above 12000.

Some analysts explain this away with hedging. “When euro-denominated assets rise, more euro selling is required to compensate for the higher share of euro assets in the portfolio, which in turn will drive more euro weakness,” wrote analysts at Danske Bank Monday.

The obvious question is when that might snap. “We are skeptical that the euro will continue to ignore the positive development [in the eurozone economic performance] in the coming month and expect a comeback of the currency by June or July this year,” says David Kohl, currency strategist at Julius Baer.

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