Bottomline: Why is EUR defying gravity in the face of positive US data and deteriorating Greece negotiations? BofAML’s Head of APAC G10 FX Trading, Rob Ettinger and BofAML’s Head of FX / Rates Strategy, David Woo argue a combination of the below factors are to blame. Of course, there is the continued debate surrounding a Greece-less EUR leaving the single currency stronger. Many agree, but only after an initial test of some of the other major regional bond markets like Italy.
Rob Ettinger:
1. Euro had become the favorite funding currency the world over with significant leverage being added in the past year. Given the move we’ve already seen, and the fact that higher vol lowers the risk adjusted return for your carry, risk aversion should lead to unwinding of these carry trades which require buying of EUR.
2. Price action would suggest there are still residual short Jpy-X (inc eurjpy) positions being unwound as well as general position reductions supported by internal and CFTC stats.
3. Many portfolio managers may have been significantly underweight Euros for some time now. As the Euro has depreciated and European fixed income has sold off materially, this would provide a good entry point to slowly start to reduce/ take profit on underweight positions.Furthermore, Rob highlights that Q1 saw every sector of client selling EUR – Corps (increasing revenue hedges and issuing debt in Europe) and moving into USD (Net investment hedges), the official sector were arguably passively and proactively reducing Euro reserves, the HF community was aggressively selling to record levels, any real money accounts who missed the first legs of the move we’re playing catch up. Which ones of those still need to sell more now? Not enough to offset the buying needs driven by the 3 reasons above.
David Woo:
Reduction of FX hedges associated with US holdings of European equities
Remember, many foreign investors bought European equities earlier this year on a currency hedged basis. According to BofAML US equity desk, our equity flows suggest US investors have reduced very little of their long European equity positions lately. In theory, as European equities fall (like today), US investors will need to reduce their FX hedges which translates into EUR buying. If such holdings by US investors are $200bn, a 2% drop in eurozone equities would lead to $4bn of eur/usd buying.
This channel may be why ironically for euro to go down, we need european equities to go up.
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