Photographer: Tomohiro Ohsumi/Bloomberg

Euro's Resilience Headed for a Test If These Charts Are Right

  • Technical indicators show historically high long-euro position
  • Currency is vulnerable to reversal amid U.S. growth momentum

As bullish euro bets pile up, it may be time for a breather.

While it’s still the best performing Group-of-10 currency this year, the euro’s momentum against the dollar has been undercut over the past month as markets have repriced U.S. growth and interest-rate projections higher.

Bulls tout the positive economic and political outlook in Europe but bears point to signs of overheating risks in the rally. The common currency remains above its short-term fair value against the greenback, according to strategists at UBS Group AG. 

Here are three indicators that might indicate speed bumps ahead.

Rate differentials

The euro may have to sell off to catch up with the bond market. Investors are betting the currency still has momentum even as the yield spread -- the premium investors demand to own two-year U.S. Treasuries versus similar-maturity German government bonds -- has widened and is close to its March peak, notes Marc Chandler, Brown Brothers Harriman’s global head of currency strategy. 

The rise in the differential was associated with bearish bets a year ago, but now it comes with bullish wagers. Euro long positions in the futures market are around 98,000 contracts -- a year ago, speculators were net short 100,000 plus.

Speculator positioning

In fact, taken on their own, long euro-dollar positions have reached the highest since May 2011. A “profit-taking wave” can come from either side of the currency pair, according to Nick Kounis, head of macro and financial markets research at ABN Amro Bank NV. “Sooner or later, investors will probably take profit on a part of their euro longs resulting in a sizeable euro correction, not a trend reversal,” he said in a client note.

Option extremes

Another indicator showing demand for the shared currency is aggressive comes from risk reversals, a measure of the appetite for bullish bets relative to bearish ones. In September, one-year risk reversals turned toward favoring euro calls for the first time since 2009, though the market has since slipped from its eight-year high. At current levels, the options market may be eliciting a contrarian signal, indicating the currency pair is vulnerable to a selloff.

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