FX Markets Weekly: ECB Seals Euro's Fate As A Funding Currency
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FX Outlook: ECB seals euro's fate as a funding currency
The EU’s unprecedented measures to avert a broader sovereign credit crisis should be good for cyclical currencies
medium-term. But for EUR the cross-currents are substantial and unquantifiable (sovereign stability and reform of EMU’s
key institutional flaws vs debt monetization and more protracted monetary accommodation). Rapid and successful
implementation of the ESM could yet stabilize EUR/USD but risks are substantial. At best EUR faces life as a persistent
funding currency – we cut our EUR/USD forecasts to reflect ECB/Fed divergence.
FX Derivatives
Euro-area intervention last weekend to stem the sovereign credit crisis is near term vol bearish; EUR crosses offer the
best value as front-end vol shorts. Headway in resolving the post-election deadlock in the UK should prove bearish for
GBP-cross vols; sell 6M 25D GBP/AUD strangles. Dual GBP/AUD vs. EUR/AUD call no touches yield bearish spot and vol
exposure in both crosses with limited downside.
Trade Recommendations
EUR has moved swiftly from worrying about the disease (sovereign stress) to fearing the cure (monetary debasement).
Increase EUR shorts but primarily where fundamentals are strongest (INR and IDR). Sell EUR/USD as a partial hedge to
long risk exposure and take profits on cyclical CAD longs versus EUR, JPY and USD. In a confused world CHF stands out as
a beacon of fiscal and monetary rectitude – stay long vs EUR and GBP in cash and options.
Technical Strategy
The medium term trends are intact despite the recent volatility. Commodity currencies should continue to outperform as
risk sentiment recovers with CAD expected to lead the way following the breakout through a number of important levels
against the USD and on the crosses. MXN and BRL have reasserted the bullish bias as the early-May sell-off fails to
extend. Look to sell corrective retracements in USD/MXN and EUR/MXN. Stay short EUR/AUD, EUR/CAD and GBP/CAD.
FX Alpha Strategies & Manager Performance
G10 Carry strategies are higher this week. The forward carry strategies remain long the USD across the board and short
EUR, except against CHF. Hedge funds are up by about 1% for the week.
Research Notes
Reflections on negative interest rates in Switzerland, (Paul Meggyesi)
FX Forecasts
EUR/USD targets lowered to 1.25 for Q2/Q3 and 1.20 in Q4, with follow-through revisions to EUR/GBP and GBP/USD.
ENDS