EUR And CAD Need To Square Up To Growing Threats
Greg Gibbs | Oct 20, 2017 16:21
The market has spent much of this year unwinding a structural short EUR position. Bank analysts have shifted to a bullish long-term EUR view, ECB QE taper is largely priced-in, the political risk gap between Europe and the USA has narrowed, and the EUR is now stretched from its widening yield disadvantage.
Traders appear to hold an extreme long EUR position, and a head-and-shoulders top appears to be developing; a break of recent lows might target a fall to 1.13. The US is making progress towards tax reform, and the market is too sanguine on US inflation risks.
Traders also appear to be holding extreme long positions in CAD, the Bank of Canada has shifted its tone on its policy outlook, Canada's housing market is slowing, and negotiations on NAFTA are not going well (although have been extended).
The USD may be pulling out of down-trend this year
The USD may be starting to show signs of pulling out of the falling trend since the beginning of the year. A key resistance for the USD will be the recent high established around a week ago. A break above that level will tend to support the notion that its recovery over the last month is real and can build into year-end.
EUR direction may be key for USD
Arguably, one of the driving forces behind the weaker USD trend this year has been a relentless rebound in the EUR. To some extent, this mirrors the strength in the JPY last year that contributed to a weaker USD trend through the first three quarters of 2016. In both cases, the market ignored the protests of the central bank guardians of these currencies and their ongoing commitment to accommodative monetary policy.
To be fair, in the case of the EUR, the ECB is moving towards a taper, whereas the BoJ is still deep in its most accommodative stance. Nevertheless, the ECB has been at pains to emphasize “patience and persistence.”
Unwind in structural short EUR largely complete
The bottom line is that both the JPY rebound last year, and the EUR rebound this year appear to have been driven by a significant unwind of structural shorts in these currencies.
Very few analysts have made mention of interest rate or yield differentials as a factor in their EUR forecasts this year. Quite simply these have tended to play little part in EUR direction. Instead, they have discussed the EUR as responding to a more solid and sustained growth path and capital inflow to its equity markets.
We can only guess as to when the broader market has unwound a structural position (in this case a short EUR). Time is a factor; it has been a 10-month period of strength in the EUR, not dissimilar to the period of JPY strength last year before it reversed course.
Another factor might be judging market sentiment. FX analysts have come around to now forecasting a stable long-term recovery in EUR. Bloomberg shows the median forecast is for 1.20 in mid-2018, 1.22 at end-2018, onto 1.25 over the two and three-year horizon. This is probably indicative of the broad sentiment in the market, and we might conclude that, on balance, investors are no longer significantly under-weight EUR.
QE taper priced-in
Another way to assess structural positions is the reaction to recent news. The market no longer appears to be reacting much to news that the ECB is set to taper its QE purchases for a second time in January, with an end to purchases insight around Q3 next year.
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