Jawboning remarks from European Central Bank president Mario Draghi, noting that the rising euro is increasingly becoming relevant to the ECB’s inflation outlook, sent the euro tumbling Thursday.
On the euro, ECB President Draghi said, “The strengthening of the effective euro exchange over the past one and a half years has certainly had a significant impact on our low rate of inflation and, given current levels of inflation, is therefore becoming increasingly relevant in our assessment of price stability.”
Going forward, “the real interest rate spread between the euro area and the rest of the world will probably fall, thus putting downward pressure on the exchange rate, everything else being equal,” he said.
For weeks, if not months, euro bears have been waiting for Draghi’s scenario to play out. They have long believed that the U.S. economy would outperform the eurozone economy in 2014, and that U.S. Treasury yields would move higher faster than eurozone yields.
Yet each time they tried a short euro position, some turn of events transpired to push the pair higher and stop-them out.
“The only thing Draghi did not say was that the euro is ‘brutally high,” quipped Steve Englander, global head of G10 FX strategy at CitiFX, referring to former ECB president Jean Claude Trichet’s market-moving phrase about high euro levels from yester-year.
“There have been an ascending series of comments from ECB officials soft-circling the EUR as a source of concern; They always cite it as a factor on the inflation outlook not as a target on its own and not because it may directly hurt growth,” he noted.
The market will have to decide if his comments altered any of four pro-EUR factos, Englander said.
First, “Italy and Spain yield are 60 basis points more than Treasuries and the euro is considered a safe haven, so capital wants to flow in (German-U.S. rate is ignored),” he said.
Then, there is “repatriation of assets from abroad as banks shrink balance sheets,” possible euro demand by Russia and China “for diversification and safe haven reasons,” as well as attractiveness of the eurozone’s current account surplus,” he said.
While the current account surplus “isn’t going away,” the question remains whether Draghi is truly promising measures to make capital inflows less attractive or hinting at balance sheet expansion, Englander said.
“I would tend to think that the ECB is still unwilling to make a big policy move that would increase the supply of EUR assets and lead to selling, and investors are unwilling to believe they will keep rates low enough long enough to alter long-term rate of return forecasts,” he said.
“Given the success of ‘whatever it takes’ investors may be reluctant to fight escalated Draghi comments in the short-term, but on balance these are likely to fade if no further action follows,” Englander said.
Traders saw Draghi’s comments as “important,” but at the same time, after having been burnt far too many times on euro short positions, they were reluctant to say the euro rally has run its course.
“It’s one thing is a lesser ECB official says something; it’s another that Draghi said something,” one analyst said.
Of the euro centric comments made, “It’s a little explicit for a central bank to say,” he said.
The euro was trading at $1.3860 Thursday afternoon, on the low side of the day’s range of $1.3846 to $1.3967 (highest level since October 2011.
Before Draghi’s remarks, the market would not have been surprised to see the euro vault the psychological $1.4000 mark, with some technical analysts seeing scope for a rally back to the October 27, 2011 peaks near $1.4247.
A break of the March 11 lows near $1.3834, if followed by a move below $1.3825 (the Feb 28 peaks, now acting as support), would suggest the euro uptrend is over traders said.
In terms of positions, weekly CFTC data in 2014 on speculative euro holdings have been a mixed bag of modest euro longs and shorts, with the net position generally under 15,000 contracts. Only positions over 100,000 contracts in the majors would be considered “extended.”
The 23,452 contract net euro long seen for position as per March 4 (latest CFTC report) was the largest net long seen since December 31.
The recent euro rally above a downtrend from the record peak from July 2008 had Bob Sinche, global strategist at Pierpont Securities, paying attention.
He remained comfortable with Pierpont’s EURUSD short recommendation, saying, “Our concern about the technical break would be greater if there was evidence suggesting an aggressive short position, particularly among speculative investors.”
Sinche pointed to the CFTC data, noting that the latest net euro long was “over 23,000 contracts, not an extreme, but compares to an average net short position of about -36,000 contracts since the beginning of 2011.”
“In this context, positioning does not suggest a squeeze on positioning is a risk to short EUR/USD exposure during the weeks ahead,” he said.
Pierpont will eye Friday’s CFTC data on positioning, anticipating that the net long euro position may have risen further.
At current levels near $1.3860, traders were watching the euro closely, wondering if this sell-off, like so many others, would be short-lived.
On the topside in the euro, above the overnight highs, there are option barriers at $1.3975 and $1.4000.
Barclays technical strategists said the euro faces a tough hurdle at $1.4000 “and other resistance levels in the form of the monthly cloud top” which converge in the area.
“We are modestly bullish for the time being, though a strong close above $1.40 (particularly on a weekly basis) would strongly argue for continued EUR strength over the medium term,” they said.
Barclays says a 1.40-plus close “would likely warn of a return to $1.4250 and $1.4440.” As a reminder, the euro topped out around $1.4247 Oct 27, 2011. The 2011 high was near $1.4940, seen May 4, 2011.
A euro close below $1.3895 would cause the strategists to rethink their near-term view. Their ideal euro buy zone is $1.3770-$1.3800.