With Euro Bears This Rabid, Pimco Says Shorts a Risk
Sentiment in the foreign-exchange market is so bearish toward the euro that it’s bullish.
Hedge funds and other large speculators have now wagered more on a decline in the 18-nation currency than about any time in the past two years, based on Commodity Futures Trading Commission data. The last two times pessimism reached fevered levels -- in May 2010 and June 2012 -- the euro rallied.
After falling about 4 percent from this year’s high in May to its lowest level since November, more investors say that much of the region’s bad economic news is priced in the currency. That means there’s a greater chance the euro will rebound as the bears cover their so-called short positions on data showing anything other than weaker growth.
“Euro shorts are stretched to the point that they make the euro vulnerable to near-term reversals,” Thomas Kressin, the Munich-based head of European foreign-exchange at Pacific Investment Management Co., said by phone on Aug. 8. “Any move lower in the euro will be glacial.”
A repeat of 2010 and 2012 would jeopardize European Central Bank President Mario Draghi’s wishes for further weakness to help boost inflation and exports in a bid to bolster the regional economy. The ZEW Center for European Economic Research in Mannheim said yesterday that its index of German investor confidence, which aims to predict economic developments six months in advance, dropped to 8.6 in August from 27.1 in July.
A report tomorrow will confirm euro-region inflation slowed to 0.4 percent in July, less than a quarter of the ECB’s 2 percent target, economists surveyed by Bloomberg predict. A separate poll suggests growth next year will be half the 3 percent seen in the U.S. An Aug. 6 report showed Italy slipped last quarter into its third recession since 2008.
The euro has fallen against 11 of its 16 major peers tracked by Bloomberg over the past three months. It touched $1.3333 on Aug. 6, the lowest level since November, before trading at $1.3358 at 12:14 p.m. in London.
Investors’ wagers on a decline in the currency exceeded those on a rally by 128,747 contracts in the week ending Aug. 5, CFTC data show. The total net-short position of $21 billion represented the biggest bearish wager among major currencies, according to the Washington-based CFTC. As recently as May there was a net-long position, totaling 32,551 contracts.
Bearish bets increased to an all-time high of 214,418 contracts in the week ending June 5, 2012. By late July of that year, the euro had bounced back from a two-year low and rallied 13 percent through the end of January 2013.
Net shorts climbed to a then-record 113,890 on May 11, 2010. A month later the euro was on its way to an advance that took it 24 percent higher by the following April.
Those rallies were the result of coincidental factors such as Draghi’s July 2012 pledge to do “whatever it takes” to save the euro amid the region’s sovereign-debt crisis, according to Nomura Holdings Inc.
“There is no such announcement around the corner at the current juncture, making a sizable reversal less likely,” Jens Nordvig, managing director of currency research at Nomura in New York, said in an Aug. 11 client note. “We are sticking with euro-short exposure,” he said, referring to a bet on further declines.
Draghi said Aug. 7 that conditions are ripe for additional declines in the euro amid a split in euro-region and U.S. monetary policy. The ECB cut its main refinancing rate to a record 0.15 percent on June 5, while futures show investors expect the Federal Reserve to raise rates in mid-2015.
While Pimco, manager of the world’s biggest bond fund, the $223 billion Total Return Fund (PTTRX), agrees with Draghi on longer-term euro declines, it doubts the capacity for near-term losses.
Kressin cited “geopolitical tensions” such as conflicts in Ukraine and Gaza, which mean “people don’t want to keep an extreme position when they don’t know what will happen next.”
Traders, and Draghi, may be overestimating the strength of the U.S. economy and how soon the Fed will lift borrowing costs, according to Rabobank International. Higher rates tend to draw international investors to a nation’s financial assets.
“We’ve begun to see the rate-differential story playing out in favor of the dollar, but whether or not there’s more room for the euro-dollar exchange rate to go lower, quickly, from here is questionable,” Jane Foley, a senior currency strategist at Rabobank in London, said in an interview. “We don’t see the euro going to $1.30 in a hurry.”
While Goldman Sachs Group Inc. last week called the end of the rally in Spanish to Italian bonds that has supported the euro, others said it has further to run, which would limit the currency’s scope for declines.
The spread between Spanish and German 10-year yields widened to 1.52 percentage points, from 1.2 points on June 9, after narrowing from 6.38 points in July 2012.
“The time for maximum overweight in peripheries has probably passed, but we are reluctant” to bet on their declines, Isobel Lee, the head of global fixed-income at Insight in London, said in an interview. “They still offer a reasonable spread over German bunds.”
To contact the reporter on this story: Anchalee Worrachate in London at firstname.lastname@example.org