This analysis is by Bloomberg Intelligence Chief G10 FX Strategist Audrey Childe-Freeman. It appeared first on the Bloomberg Terminal.
Last week’s Fed and ECB policy messages didn’t get the euro-dollar beyond $1.10, but the cyclical narrative remains supportive and this is a time to be patient, and maybe diversify, not give up. Recent euro hesitancy may reflect a market that’s long already, or a wait-and-see mood until the air clears on US debt limit and regional-bank headlines.
Fed, ECB narratives for May: Euro-dollar bullish
Last week’s Federal Reserve and European Central Bank policy meetings confirmed the leading nature of the Fed over the ECB, with a pause in tightening looming or already here in the US and clear signals that such a breather is no where to be seen in the EU, with more hikes likely. This implies that the euro-US relative yield differential should continue to improve this year, and that’s been, and remains, a prime bullish driver for euro-dollar.
On May 3 and 4, the Fed and ECB each hiked rates by 25 bps, to 5.25% and 3.75%, respectively, with the two-year yield differential near 135 bps.
Fading risk appetite brings euro hesitation
Risk appetite has been less of an influence for G-10 FX markets this year, with multiasset-class correlations falling substantially as yield differentials and expected growth variations rule. Yet the market backdrop remains highly uncertain and could become more of an FX driver in the near term, with the US debt limit question unresolved as the clock ticks down and negative headlines continuing to rattle regional banks. We believe that, given the idiosyncratic nature of those risks, they’re dollar negative anyway, but there’s clearly an element of uncertainty that may explain the euro-dollar’s recent hesitations.
As of May 5, the Euro Stoxx 50 traded about 14% higher year to date, doubling a nearly 7% rally on the S&P 500, with the euro-dollar up about 3.7% over the same period.
Market long euro, possibly overstretched
When it comes to euro-dollar positioning, single-currency bulls look tired and arguably stretched. Leveraged funds have just gone back to overweight euro positions, CFTC data show. Crucially for clues on long-term market positioning, asset managers have added significant exposure since early January, with an exponential increase in longs. The sharp early-1Q increase in longs came with a spot-price revival to near $1.10 by the end of January. A further jump in early 2Q captures downward risk should sentiment adjust negatively and the longs unwind.
As of April 28, leveraged-fund contracts on the euro stood at plus 3,448 from minus 8,123 on Jan. 6, and asset managers at plus 460,802 (plus 378,981).
G-10 central banks at different stages, FX impacts
G-10 central banks are at different points in the monetary normalization processes, with implications for near-term yields and currency prospects. Though the Fed’s tightening cycle overwhelmingly supported the dollar a year ago, a nearing rate peak and subsequent focus on the timing of cuts mean the yield-driven dollar upside is a thing of the past, despite what remains very helfpul nominal yields.
