Citi On The Euro's Surprising Resilience And Why "At These Prices We Are Not Buyers"

Tyler Durden's picture

While over the past week we finally got confirmation that while the Swiss franc reserved its place at the top of the foreign exchange pantheon as the last flight to safety currency (with dollar concerns expressing themselves in the form of accelerating DXY selloffs predicated by fears of QE3 should oil continue rising higher or the world economy deteriorating), the one surprising discovery has been the stunning resilience of the Euro in light of relentless bad news. We have already noted our concern that March is rapidly coming, and brings with it a vicious calendar of European political upheaval and debt maturities, which should only be ignored at the peril of other people's money. Confirming our Euro-skepticism is Citi's Steven Englander who has released an extended note earlier titled "EURUSD - why so strong" which seeks to explain why the EURUSD is not trading a few hundred pips lower. Englander's conclusion: "we still find it hard to sweep away sovereign issues, especially if private sector positions continue to creep up. Under a benign global outcome, we continue to see better currencies to buy than the EUR, and under a not-so-benign outcome, we expect that the run-up in risk aversion will be a significant EUR negative. At these prices we are not buyers." Yet someone is...

Englander's summary of recent developments:

The euro has rallied so far this year and has kept its gains despite market (and our) skepticism that sovereign debt issues have been resolved. The 2011 rally is driven by incentives for reserves diversification, rate differentials moving in the euro’s favor, rebuilding of long EUR positions and improving global risk appetite. We find that the EUR is reasonably priced given the above factors. However, it is less clear that these factors will continue to evolve in a euro-positive direction.

In particular, investors appear to be buying the EUR on the back of increasingly optimistic comments from the ECB about the state of the euro zone economy. But incoming data largely reflect November-January conditions and probably not the conditions that would exist if there was a major oil shock. We think that FX investors may begin to reconsider their optimism.

The EUR is sensitive to a global oil shock because such a shock will likely lead to a reduction in risk appetite, a cutting of positions with respect to risk-correlated assets and slower growth. The major economic risks if these shocks intensify are for capital goods exporters, oil importers, and non-oil commodity exporters – and their currencies. The EUR is sensitive to the first two. More broadly, slower growth and risk aversion would make investors price sovereign debt more negatively, and if that is the direction in which global asset markets are moving, it seems unlikely that the EUR rally would continue.

One tactical reason for the strength of the EURUSD is, as we have repeatedly shown in our CFTC COT updates, that both speculative and structural position in the EUR is no longer short: it appears that the most famous trade of H2 2010 has fallen out of favor.

Many market participants started 2011 holding EUR-shorts. The leg higher in EURUSD on the back of hawkish Trichet comments in the second half of January took some by surprise. The recent path of our daily CitiFX PAIN positioning indicator seems to corroborate this conclusion (Figure 2). PAIN measures the correlation between hedge fund performance and EURUSD returns. The indicator picked up at the start of January as EURUSD weakened but then weakened noticeably later on as the leg higher in EUR seemed to be hurting hedge fund performance. According to PAIN, hedge fund positioning caught up only gradually with the move higher in EURUSD (PAIN started growing again in February as shown in Figure 2). IMM data further suggest that a broader group of FX market investors were caught wrong footed when the EUR started rallying in mid January. Consistent with the PAIN indicator, the IMM data also suggests that there has been a gradual build up in EUR longs which intensified in February (Figure 3).

Europe's biggest risk continues to be its fragmented fiscal policy, and the increasing protests against austerity and banker bail outs, today's Irish vote being one of the bigger risks:

EUR downside risks are still dominated by the situation in the euro area periphery. We have seen and heard European politicians talk about finding a comprehensive solution to the problems of the fiscally weak euro area member states. However, Portuguese funding costs continue to hover close to record highs highlighting the likelihood of Portuguese bailout in coming weeks. While we have seen some correction in Spain-Germany yield spreads, these remain very elevated historically and suggest that some risk remains.

The bailout problem could come to the fore much sooner if the Irish opposition parties stay true to their pledges and demand a re-negotiation of the Irish bailout following a likely victory in tomorrow’s election. Importantly, such demands could be met with firm opposition by countries like Germany where the ruling coalition is desperately trying to improve its standing with an electorate which is turning increasingly hostile to growing German participation in the peripheral rescue effort.

In a zerosum world, is the recent atavism against the (temporarily?) former reserve currency a direct reason for the EUR's resurgence?

Sovereign USD-selling can explain some of the EURUSD resilience…

Fully quantifying the extent to which the EURUSD resilience recently has been due to USD-selling by reserves managers is difficult. Anecdotal evidence, as well as indications that the so called ‘currency wars’ practices and rhetoric of late, seems to corroborate the view that global reserve managers were indeed active buyers of EURUSD recently. There were indications at the start of the year that Asian investors will purchase peripheral assets or participate in the bond auctions of the EFSF. While the indicated amounts were rather small overall, we think they sent a credible signal about the intentions of global currency managers in their (apparently) continuing efforts to diversify away from USD. This interpretation seemed to persevere even as price action in the peripheral debt markets was turning less supportive of that view in February.

One way to gauge the extent to which USD-selling added to EUR-resilience is to compare the relative performance of EURUSD and EURCHF over the last few months (Figure 4). The level of EURCHF is a well known proxy for the magnitude of perceived risks in the euro area periphery. At the same time, USD-recycling seems to be less of a driver for CHF. As shown in Figure 4, EURUSD clearly outperformed EURCHF. This was particularly true over the last few weeks when we saw a renewed widening of the peripheral spreads to Germany (see also Figure 5). The key risk associated with the feed back loop between USD-recycling and EURUSD is that USD selling could come to a sudden stop against the background of sharp deterioration in market risk sentiment. Foreign safe-haven demand tended to pick up during bouts of risk aversion like the two sovereign bailouts in the euro zone in 2010 (Figure 6). This was supportive for USD (see also the EURUSD path in Figure 2).

Englander's bottom line: sell.

The big EUR pluses are the chronic global overhang of USD among reserve managers, the perception of a bias towards easing in US monetary policy, the lack of credibility of fiscal policy, and the perception that US policy is oriented to dollar weakness. Admittedly, these are hefty USD negatives and we expect them to dominate in the long term.

In the shorter term, we think investors are overestimating the EUR’s resilience in the face of global supply shocks. Even in their absence, we still see significant risk that sovereign issues return to the front burner as significant differences become increasingly difficult to paper over. In the past, sovereign pressures have been correlated with German-US spreads moving in the USD’s favor as well, as investors piled into German government bonds. Notwithstanding the price action, we still find it hard to sweep away sovereign issues, especially if private sector positions continue to creep up. Under a benign global outcome, we continue to see better currencies to buy than the EUR, and under a not-so-benign outcome, we expect that the run-up in risk aversion will be a significant EUR negative. At these prices we are not buyers.

Full report

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Yancey Ward's picture

Maybe the strength is a reflection of the belief that, if countries like Greece are shown the door, the resulting monetary union gets stronger, not weaker?

Sophist Economicus's picture

Who cares about these 'currencies' -- trade dollars and euros for gold and silver.  If i can get more gold with euros -- neato!

LawsofPhysics's picture

Englander has a short position.  Yeah, sell so he can make more money.  Enough with the shilling already.

doomandbloom's picture

off topic but an interesting conspiracy theory. 

Revolutions in Middle East To Kill Islamic Banks In Emerging North African Markets.


SilverRhino's picture

I don't like islamics religion much but yeah I'd bank with these guys.   Can't be any worse than the current shysters.   Throw in a gold/silver backed dinar and I'm all in.


vas deferens's picture

The euro takes more then one country to decide to print more euros.  Having the money chimp at the head of the US FED, only needing to press a button, the dollar is sure to fail first.

Flore's picture

Hey Tyler .. you should take a closer look at the ECB reserves... 66 % gold reserves.. marked to market every quarter... That's why the Euro will be the clear winner worldwide... You heard it here first...

Non Passaran's picture

Yeah, right.

They could probably spend it all just to return a fraction of their debt.

Disc.: long physical PMs and PM miners.

Ferg .'s picture

Interest rate expectations have probably played a role . They've taken a notable upward turn lately . That and Asian CB diversification .

EUR/USD continues to be an almighty pain in the ass to trade .

Bleeping Fed's picture

I'm in agreement on the Asian CB diversification.  Although I think the diversification is more like China trading dollars for Euros to prop up their biggest export market.

Ferg .'s picture

Good point , and the Chineses did state very publicly that they'd be willing to step in and buy periphery bonds .

joemayo's picture

USD value is supported by its ability to reliably purchase oil.  If it cannot do that, then EUR value should increase relative to USD. 

If this ability remains in doubt for long, a no-fly zone will be declared over Libya (and then others) for humanitarian reasons, so that the humanitarian marines can then more easily make their way From the Halls of Montezuma To the Shores of Tripoli.

Dr. Richard Head's picture

Citi was a buyer of a $0.38 on the dollar settlement of credit card debt, so thay works for me.  Taking the difference in debt owed and settled and tossing some PMs me way.  Fuck Citi and the horse they rode in on.  I'll make me own bailout.

Oso's picture

they re just annoyed GS dg'd them today. 

Quinvarius's picture

Because the Euro is a stronger currency than the Dollar no matter how many interventions the US does to prop its toilet paper up.  We have probably given away 20 trillion Dollars in loans and bailouts since 2008.

I still don't get the whole weak Euro thing.  It seemed obvious to me that the US was pounding on the Euro to make the Dollar look better until the Chinese stepped in and took the other side. The supply of Dollars is massive.  It has to continue losing purchasing power.

THE DORK OF CORK's picture

The euro weakness is somehow perceived as a strength - as this is mainly interpreted by bankers this is no surprise.

Most of the money is created by commercial banks - the ECB has bought only something less then 10% of their balance sheet on Gov debt 

The bankers have projected a false metric on the public - the low CPI inflation rate of a unit of euro currency -but the physical economy has been wasting for some time in Europe as the shadow bank sector grew over the sovergin by extracting a capital destructive yield over the remaining bits of the physical economy.

Wage earners are experiencing inverse inflation as their wages are falling relative to goods and services -  this is the stated objective of the ECB.

Their goal seems a Volcker policey of wasting the exterior to sustain the yield on overvalued debt currency with devastating results on Industry.

They may succeed to sustain the euro but at the cost of real wealth in the form of physical capital destruction


ISEEIT's picture

Short euro to 135.7.

It's just a bouncy bounce game. Depends on the time frame (perspective). Both fiats are going to get flushed but you can make a buck betting on the trip down (who falls faster) VS (who gets wings for a bit).

I think the 5min to 10sec chart are the most fun with a subconscious awareness of 30 day plus sentiment. Longer windows are (IMHO) garbage. Just look for a contest in the short areas and make small bets.

JonTurk's picture

EUR should have been crashed in this week's risk off but it stood like a rock.

market is giving a major signal about US currency: two gigantic negatives taking its toll on USD;

1- Middle East crisis and uncertainty about the region is a big (-) for US, considering its decades long dominance over the area

2 - QE to n virus started to eat into the basis of reserve currency status; re: UST10 topping out, Asian sovereigns unwinding US debt


Jack Sheet's picture

..."Globally, Central Banks continue to sell the USD against the SDR currencies of Europe, the UK and Japan, with those of Australia and Canada gaining additional flows.  This will not change.  Nor will the considerable yield differential between US and European 2-year swap spreads, last quoted at 109 basis points in Europe's favor.  While Europe may be taking a step backwards, news of US Fiscal duress are beginning to come to the fore..."



rayban's picture

The recent euro strenght is VERY suspicious. Weber is gone and is openly critical of current EU policies, Merkel loses Hamburg, rioters attack policemen in Athens once again, Irish elections over the weekend could mean a package re-negotiation and we have only 15 days in advance of the EU summit at the end of March to find a unanimous agreement on EFSF extensions before Finland dissolves its Parliament... I guess Trichet is going to be really hawkish next Thursday! At least that's what some big guys must be thinking, since the net euro long positions have increased to 45600 contracts as of February 22. Just in case he'll disappoint them all, I'm buying now some April 1.34 puts at approx. 0.0090 (11.5% vol).

jonytk's picture

Eur weakness is considered an strengh because as soon as Euro falls under 1,20 Germany exports skyrocket, and Eur above 1,4 hurts exports but help cope w/ gas prices.

So here you got the explanation, as simple as that. ECB helped by the loose organized, but not dumb, EU politicians just have to open their mouths to move the Eur up/down.

Itsalie's picture

The main reason why "talking the euro up and down" works is because the forex market has ballooned into another HFT hedgies paradise: all their programs are cued to tghe latest artificial intelligence-driven key-word speech-to-text translation algos. Whenever the algo sees the words "Trichet/Weber" together with "inflation", its buy Euro. Ten years ago, there wern't such rubbish AI-driven algos and alot less wet-behind-the-ears 24 year old PhD hedgies", and whenever the ECB tried talking the euro up when it was below parity with the USD, they get the euro sinking faster the next day.

Plus china/japan have a pact to basically prop up the currency of their biggest trading partner (yes the euro zone, no not amerika aka zimbawe), seeing how screwed (aka over-leveragd) the american consumer is and how the chimps in the Fed / Congress are hoping to "create jobs" while enriching their masters (aka the banksters) and their key campaign sponsors (aka big businesses) by printing more toilet papers (at least the hypocrcats in brussels aren't openly saying they are conducting QE - so the HFT algos would never be cued to see the words "Trichet/Weber" and "QE" together, so never have a chance to "sell euro")). Everything else, including the freaking swap markets are cued to the same algos. So the inevitable outcome is whenever euro touches a key round number like 1.33 or 1.35, you have JBTFD! (aka just buy the !@#$% dip).

scratch_and_sniff's picture

Probably very convincing, more moving parts than a flux capacitor, its a shame im such a ludite. Seriously, i have to snigger at the growing complexity of these arguments, what a silly broth. Is this guy looking for pips from these arguments or a nobel prize for juggling trifles? I wonder how seriously he takes it all? Overhangs, perceptions, sentiments, credibility’s, orientations, diversifications,relativities, overestimations, correlations, indications, pressures, participations, incentives, magnitudes, intentions, aversions, proxies, rhetoric, intensities, appetites, feedback loops…what a complete fucking maniac. Do me a favour!

bluebare's picture

Realpolitik at play here, too.  Who's buying?  Chinese have as much as said they're supporting Euro (and left unsaid "at least until the USD goes under").