Most-Accurate Forecasters on Euro Clash With Options Sign
The world’s most-accurate foreign- exchange strategists say the worst is over for the euro this year, putting them at odds with traders who see more pain as the region’s economy shrinks and the sovereign debt crisis deepens.
Led by Wells Fargo & Co. and Westpac Banking Corp. -- which correctly called the euro’s weakness last quarter -- the five best firms as measured by Bloomberg expect Europe’s 17-nation common currency to end the year at about $1.26, up from $1.2299 as of 12 p.m. New York time. That’s above the $1.24 median estimate in a survey of 55 strategists by Bloomberg News.
After sliding in April and May, the euro’s drop slowed in June against a basket of currencies tracked by Bloomberg as European Union leaders approved measures making it easier for Spain and Italy to obtain aid, setting the stage for greater fiscal cooperation in a region where five nations have sought bailouts. While strategists are optimistic, derivatives show traders are about the most bearish ever on the euro versus the dollar over the next 12 months compared with the next 90 days.
“We expect within the ebb and flow of the European debt crisis that things will get better rather than worse this year,” said Nick Bennenbroek, the head of currency strategy in New York at Wells Fargo. “Not only were the decisions that were taken in June by European leaders positive, but we continue to see supportive movements from the central bank as well.”
Wells Fargo expects the euro to reach $1.26 next quarter before easing back to $1.24 in six months. The bank, whose currency calls had an average margin of error of 3.52 percent, was the most accurate forecaster for the third consecutive period, according to data compiled by Bloomberg, topping runner- up Westpac’s 3.55 percent.
The euro jumped 2.4 percent against the dollar in June, its best month since October, before falling 3 percent last week to $1.2291 and depreciating 3.1 percent versus the yen to 97.89. Last quarter, the two most-accurate firms correctly said the euro would slide as austerity-driven spending cuts from Spain to Italy reignite debt turmoil and drag the region into a recession.
“We do look for signs of stabilization -- it’s not a doomsday scenario,” Emmanuel Ng, a Singapore-based economist and currency strategist at Oversea-Chinese Banking Corp., said July 5. OCBC, the third-best forecaster, with a 3.65 percent margin of error, sees the euro rising to $1.26 by year-end, down from a prediction of $1.35 in April.
“They are trying to untangle the mess, so that’s going to forestall a drastic collapse in the euro,” he said.
Talks in Brussels ended on June 29 with EU leaders paving the way for cash-strapped lenders to tap Europe’s bailout funds directly once they establish a single banking supervisor. Until now, they had to get aid through their governments, adding pressure to already stretched national coffers.
The European Central Bank will play a role in the new supervisory body, officials said. They also agreed to drop a requirement that taxpayers get preferred creditor status on emergency loans to Spanish banks. Other steps included agreeing to use rescue funds to stabilize markets under some conditions.
For traders, the measures won’t be enough to keep Europe’s economy from shrinking. Gross domestic product will contract 0.4 percent in 2012, after expanding 1.5 percent in 2011, according to the median estimate of 30 economists in a Bloomberg survey. Unemployment rose to a record 11.1 percent in May and economic confidence slumped to the lowest level in more than 2 1/2 years in June, reports on July 2 and June 28 showed.
One-year options show that the premium for puts, which grant the right to sell the euro versus the dollar, over calls, which confer the right to buy, is close to the highest relative to three month contracts since Bloomberg began tracking the data in 2003.
The gap between the so-called 25-delta risk reversal rates reached 1.05 percentage points on a closing basis on June 29. The difference between the two gauges has averaged less than 0.1 percentage point since 2003.
Risk reversals measure the difference between implied volatility, or a gauge of price and demand, on similar puts and calls. Traders pay a premium for puts when they expect the euro to decline.
“Europe is a very simple story, it’s a story of dramatic euro-zone underperformance and the persistent inability for policy makers to get in front of the crisis,” Richard Franulovich, a senior currency strategist at Westpac in New York, said July 3. “It’s basically a risk aversion story for the next six months. The dollar is relatively a better bet than the euro or the dollar-bloc currencies.”
Europe won’t get the power to recapitalize banks directly in time for the injection of as much as 100 billion euros ($123 billion) into Spain by mid-2013, a European official said on July 6. Spain’s bank-aid program, to be endorsed by European finance ministers this week, will channel the money via a Spanish state agency, the official told reporters in Brussels on condition of anonymity.
Westpac placed second in overall accuracy for a fourth straight quarter. The Sydney-based bank forecasts the euro will weaken to $1.20 in the next three months, and rise to $1.24 at year-end.
The difference in the number of wagers by hedge funds and other large speculators on a drop in the euro against the dollar versus those on an advance -- so-called net shorts -- stood at 159,880 in the week through June 26, the most recent period for which data are available from the Commodity Futures Trading Commission in Washington.
That compares with the record of 214,418 three weeks earlier. A year ago, there were net bets on a gain in the euro.
For all the turmoil in Europe, the euro is still trading above its lifetime average of $1.2086 and has only fallen below that level on six trading days in the past six years. Since it began trading at about $1.17 in January 1999, the euro has ranged from 82.3 U.S. cents in 2000 to $1.6038 in 2008.
JPMorgan Chase & Co., whose 3.87 percent margin of error made it the fourth-most accurate forecaster, sees the euro ending 2012 at about $1.24 or $1.25, down from an April forecast of $1.36, after moving “erratically in the $1.20s for the balance of the year,” said John Normand, head of currency strategy at the New York-based bank.
Normand cited the agreement reached at the EU summit to use the permanent bailout fund, the European Stability Mechanism, to provide direct recapitalization to banks and moves to agree on a single regulator as positive for the euro.
Rather than anything coming from Europe, Rabobank International expects the euro to rally as the Federal Reserve announces plans to print more dollars to buy bonds in an attempt to stimulate the U.S. economy. The firm, the No. 5 most accurate forecaster, with a margin of error or 3.88 percent, sees the euro climbing to $1.32 by year-end.
“While its ample liquidity will ensure that the dollar is a safe haven in times of intense stress, it’s our view that on any signs of stabilization in perceived risk, dollar longs will be cut -- potentially sharply,”Christian Lawrence, a currency strategist in London at Utrecht, Netherlands-based Rabobank, said July 3.
The last time the Fed expanded its balance sheet, purchasing $600 billion of Treasuries from November 2010 through June 2011, the dollar weakened 4.2 percent against the euro. Odds for more of that kind of stimulus increased last week after a Labor Department report on July 6 showed that U.S. employers added fewer workers in June than forecast.
Strategists were ranked according to the accuracy of their forecasts for 13 currency pairs in each of six quarters through June. To test long-term accuracy, Bloomberg Rankings added one annual estimate, which was made at the end of June 2011 for the end of June 2012.
Only firms with at least four forecasts for a particular currency pair were ranked, and only those that qualified in at least eight of 13 pairs were included in the ranking of best overall forecaster. Thirty-four firms qualified.
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