After a month’s worth of fake breakouts and breakdowns, the euro finally made its move over the past two weeks. Bearish euro/bullish USD sentiment, after many months of building, finally got to the point where the news flow needed to sustain the story became too high a hurdle.
So, where do we go from here?
To my eyes this, like many other medium terms swings in macro plays, is about extreme positioning and sentiment more than it is about fundamentals. Yes, the US economy has printed some disappointments. Yes, the data in the Eurozone have been less bad. Yes, market participants—rightly or wrongly—have been trudging toward the belief that Greece won’t trigger massive contagion even if it defaults and/or leaves the single currency. And yes, “fundamental” narratives that fit the price action will intensify to the extent the euro marches higher. But the truth is the cyclical drivers still favor the USD.
If you roughly buy into that view, then the question is reduced mostly to a technical one: how offsides are investors in their EURUSD positions and how much higher might an unwind take us?
So here’s the simple way a currency trader might look at EURUSD today.
Positioning/expectations are still offsides, i.e. the pain trade is higher.
The white line is the current spot rate. The blue lines are the one standard deviation lines using implied vols from end-June. The green bars are analyst projection through end June. (Note how far to the left of the white line they are.) The red curve is the probability distribution for spot outcomes at end-June based on the euro’s volatility surface.
The daily chart tells us we are bumping right up against short-term resistance.
The behavior behind resistance, of course, is the old I’ll-sell-it-when-it-gets-back-to-where-I-bought-it instinct.
It’s also noteworthy that in the last two days the euro rallied, other currencies (all three buckets, risk, funding and petro) stopped following. Indeed, on Friday many of them depreciated significantly, exacerbated to some extent of the moves in US rates.
Longer-term, there is much more room for positioning/sentiment normalization
It is worth noting that the chart of oil, though not identical, is similar (oil had its retest in March whereas the euro had its in April). That oil has led the euro means it should be an excellent tell going forward
Bottom line: the likelihood is the short euro unwind is likely to go further. Typically these unwinds persist until the majority of market participants reverse their views (oil recently was an excellent example of this). And we are far from that point in the euro. But the longer term fundamentals do favor, IMO, the USD, and we have run into likely short term resistance. This increases the odds of being wrong. So, if you missed the euro move off the bottom, be patient here. Most traders haven’t given up the strong USD thesis and will likely attack any short term euro weakness. These moments should give better risk/reward entry points to take a shot at the pain trade eventually squeezing the euro higher.