The euro has traded between roughly $1.0485 and $1.1100 so far this year. The average is about $1.08, where it traded above yesterday for the first time in 2 ½ weeks.
Recall that the euro rallied from around $1.05 in mid-March
(amid speculation that the banking stress was going to force the Fed to cut) to
around $1.1100, where it stalled in late April and early May.
We argued that the rate cut expectations had swung too far
and that as they converged back with the Fed the dollar would recover. The euro
hit a low at the end of May near $1.0635.
The interest rate adjustment we anticipated looked complete
or nearly so and that seemed to warn of the risk of a dollar setback/euro
bounce.
The five- and 20-day moving average simple cross-over proxy
has down very well this year. It cross higher in mid-March and lower in early
May. The five-day moving average crossed above the 20-day moving average
yesterday.
The ECB meets tomorrow. The swaps market is nearly certain
(95%) that the ECB will hike key rates by 25 bp. This will lift the deposit
rate to 3.50%. The ECB is expected to indicate that it recognizes more work is
needed to bring inflation back to its target. The market has a little more than
a 70% chance of at the July 27 meeting discounted, and, in any event, it is
fully discounted by the end of Q3. This is expected to be the terminal rate now.
The ECB will announce new economic forecasts and the risk is
that growth is cut, and inflation raised. There will also be an indication of
how it will allow the assets purchased under the Asset Purchase Program (APP)
will roll off starting in H2. Remember there are loans, under the Targeted
Long-Term Refinancing Operations, which are due at the end of the month. This
will result in a several hundred billion euro decline in the ECB’s balance
sheet.
I have two nagging concerns about the euro. First, the US
2-year premium rose above a little above 170 bp yesterday, the most since March.
I suspect it is near a high, but I have been thinking so since earlier this
month. There is scope for it to rise a bit more to challenge the year’s high
near 185 bp in early February. Its five-day moving average is above the 20-day
moving average. Second, the net speculative long position in the futures market
remains large (158.4k contracts) though it has been trimmed by 28.5k contracts
over the past three weeks. Take away:
the discretionary market is still very long euros and interest rate
differentials are moving against it.
If we use the current implied volatility and make a band
around the implied forward, it produces a band of roughly $1.0350-$1.1475. Mathematically,
assuming vol stays constant and the outcome is normally distributed, there is
about a 72% chance the euro finishes the year in that range. The median
forecast in Bloomberg’s survey is for it to be at $1.12, up a cent from a month
ago.
Reviewed by Marc Chandler
on
June 14, 2023
Rating:
