No Mayday for Euro Bears as Split in Policy Seen Capping Rally

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A hiatus, not a turning point: that’s the verdict of traders and strategists on the euro’s biggest rally in 3 1/2 years.

The single currency surged 3 percent against the dollar in the past five days, completing its strongest three-week advance since October 2011. The gains came as signs of inflation shook investors’ faith in the European Central Bank’s commitment to its bond-buying program, sending the region’s debt plunging.

Across the Atlantic, a series of below-forecast economic data have delayed the prospect of a boost to U.S. interest rates. Yet banks from ING Groep NV to Citigroup Inc. say they’re sticking with their forecasts for the euro to resume its unprecedented slide because the fundamental driver -- a split in policy between Europe and the U.S. -- remains intact.

“The shift-up in yields has helped shift the euro higher,” said Kit Juckes, a strategist at Societe Generale SA in London. “If it went on, it would explain it happening more. But the European bond market looks more like a case of position capitulation, correction and money coming off the table than a turn in trend.”

Forecasting Parity

Forecasts compiled by Bloomberg reflect that view. The median of 63 estimates hasn’t moved during the euro’s rally and still suggests the single currency is headed about 7 percent lower by year-end to $1.04. More than a third of the estimates still anticipate a drop to or below dollar parity after the euro climbed to a two-month high of $1.1290 on Friday.

SocGen itself predicts the euro will remain around current levels. Citigroup, the biggest foreign-exchange trader, and ING Groep NV, the top currency forecaster in Bloomberg Rankings over the past two quarters, both see it sliding to $1 before the end of the year.

“Parity is still very doable,” said Petr Krpata, a strategist at the Dutch lender’s London office. “The very last thing the ECB wants now is even to hint at tapering” of its QE plan. “The euro would go further up, and if they’re on the track of a very gradual recovery, they don’t want to kill it.”

The rout in euro-area bonds saw 55 billion euros ($62 billion) wiped off the value of the region’s debt on Wednesday alone.

Gundlach Effect

The slump began after DoubleLine Capital’s Jeffrey Gundlach said he was considering an amplified bet against short-dated German notes, echoing comments by Janus Capital’s Bill Gross, who said bunds were the “short of a lifetime.” This led some investors to speculate the ECB may shut down its 1.1 trillion-euro bond-purchase program sooner than the planned end date of September next year.

It’s QE that has sent the euro tumbling more than 7 percent versus the dollar in 2015, and saw it reach a 12-year low of $1.0458 in March. Data released Thursday showing consumer prices stagnated in April, ending a four-month streak of declines, also encouraged speculation ECB President Mario Draghi might seek an early end to the bond purchases.

The rally in the euro extended after Fed policy makers indicated Wednesday they’re in no rush to raise rates from near zero after data showed the U.S. economy grew at the slowest pace in a year in the first quarter.

Hedge Funds

Hedge funds have been paring net-short positions on the euro, or bets it will weaken, for most of this month. They fell to 214,645 contracts in the week through April 21, down from a record 226,560 at the end of March, according to data from the Commodity Futures Trading Commission in Washington.

Options prices suggest the single currency is set for further declines. The premium on contracts to sell the euro over those to buy has more than doubled during the past six months to 1.9 percentage points, three-month risk reversals show. While the gap has shrunk this month, it’s still higher than on March 9, when the ECB started its QE bond purchases.

“The market’s beginning to say, maybe the ECB will start tapering sooner than we expected, and that’s giving the euro some support,” said Steven Englander, global head of Group-of-10 currency strategy in New York at Citigroup. “But I think that, from the ECB viewpoint, they certainly don’t want premature support. By Q4, people will be talking about parity again.”

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