NEAR-TERM EURO-DOLLAR RISKS MAY LIE TO UPSIDE

FX 360

Despite every possible effort by the shorts, euro-dollar refuses to go down. Over the past four weeks the pair has traded in a narrow $1.3000-$1.3300 range, rebounding every time it has broached the key $1.3000 level. One reason for this remarkable resilience is the persistent skew in positioning. After a few weeks of reducing in size, euro shorts have piled back into the trade and, according to the latest commitments of trade data from the US Commodities Futures Trading Commission, have increased their bets from -140.6K the previous week to -148.6K. Although this short position remains below recent record highs, it is nevertheless massive and creates a combustible environment, ripe for a short covering rally, while concurrently making any further declines in the pair much more problematic.

Speculative markets, by their very nature, cannot allow the majority of participants to be right on the trade. Large skews in positioning to one side or the other often presage violent moves in the opposite direction. That’s why some market analysts are beginning to believe that the near-term risks in euro-dollar may lie to the upside, especially if the pair can break above the $1.3320 mark. This would force many of the long-term shorts to reconsider their view and fuel another round of short covering.

The euro negatives are well-known. Greece remains a basket case and few serious analysts believe that it can restructure effectively without eventually defaulting on its obligations, even if it receives a bailout. Yet though Greece remains the primary focus of the market, its economic importance to the Eurozone is minuscule – its GDP comprises less than 2 per cent of all Eurozone economic activity. If Greece finally receives its second bailout the country’s economic problems will not be solved, but it may pacify investors for the time being and shift the focus elsewhere.

Meanwhile support for the euro has come from an unexpected place – China. Last week PBOC chief Zhou Xiaochuan pledged that the country’s central bank will increase its holdings of euro-denominated assets. Zhou noted that China has been a consistent buyer of euro assets and will further increase its holdings, most likely through Europe’s bailout fund. He added that the euro can become a bigger and more important reserve currency.

Zhou’s comments reaffirmed China’s long-standing policy of support for the euro-dollar, which it considers to be vital to the country’s political and economic goals. As we have noted many times in the past, the Chinese are loath to see a unipolar world in which the dollar stands as the only reserve currency. They will likely do everything within their power to support the euro as a viable alternative to the greenback.

The Chinese are also providing support for euro-dollar by loosening monetary policy once again. This past weekend the PBOC has cut the reserve requirement rate by 50 basis points, signalling an easing of credit conditions for the Chinese banking sector.

Assuming the Greek bailout deal does not hit any further snags, the true test of euro strength will come this Wednesday when the market gets a glimpse of the latest Eurozone flash PMI readings for February. These will provide the most up-to-date readings of economic conditions in the region. The market anticipates a very slight improvement from the previous month. But if the data surprises to the upside it could provide the upside catalyst to push the pair through the $1.3320 resistance level and fuel a much more substantial short covering rally.

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April 22, 2014, 2:25pm