Euro Eyes Parity Once More

Bloomberg

Vassilis Karamanis

Following a failed attempt at parity earlier this year, the euro may be set to make a more convincing foray at 1.0000 to the U.S. dollar, as a crucial driver for further weakness in the common currency is now on a substantially different path, Bloomberg strategist Vassilis Karamanis writes.

One key difference this time is that the euro is facing downside pressure from investors both going short the euro and building long dollar positions.

The pair has finally broken $1.08 level for the first time since late April and threatens support at $1.0660 as it did back in late May, in a pattern that looks strikingly similar. Strong support is now seen near $1.05 where barriers may have been placed ahead of year-to-date low at $1.0458.

May vs November

The euro has seen a sharp fall against the dollar within a short period of time, reaching similar oversold levels on technical indicators. Risk reversals, a gauge of market positioning and sentiment, are close to May levels, especially in the front end, signalling that traders assign similar probabilities on trend continuation.

U.S. 10-year Treasury yields are near mid-May levels while data from the Commodity Futures Trading Commission show CME Euro FX leveraged net shorts stand at exactly the same level.

Chances of the Federal Reserve Funds rate being within 1.00-1.25 percent band at the December 2016 meeting are being priced at 21.7 percent compared with 24.1 percent in late May.

What's Different This Time

The European Central Bank recently stepped up its rhetoric to further ease monetary policy, quite a turnaround from just a few months ago when talk was that the Governing Council may end its quantitative easing program sooner than expected.

The ECB's initial monetary stimulus was already priced in the currency's drop to $1.0458 mid-March low, leaving the market to trade the dollar side of the equation thereafter.

Moreover, the Fed now seems less troubled than before by the broader dollar strength and the effect of international shocks on its economy. Last Friday's off-the-charts payroll numbers further reinforce this sentiment.

An actual Fed liftoff will confirm further widening of monetary policy divergence and spur real money and other long-term investors like pension funds, asset managers, insurance companies to re-engage in the short euro- dollar trade, thus taking the euro to fresh year-to-date lows.

Four traders in London and one in southern Europe, who asked not to be named as they are not authorized to speak publicly, say real money investors have recently sold the euro mainly against emerging market currencies and not against the dollar, the sterling and the Swiss franc.

A key risk to continued euro weakness is that the ECB refrains from further easing policy at its December meeting due to the recent decline in the euro.

Note: Vassilis Karamanis is a strategist who writes for Bloomberg. The observations he makes are his own