Goldman On Why It Is Still Constructive On The EURUSD, And Thus The Market

Tyler Durden's picture

Stocks appear to have largely ignored the technical default of the US (fire and brimstone warnings from the tax expert notwithstanding), and instead appear to be tracking the EURUSD tick for tick, as every algo continues to be an inverse USD "hedge." Earlier today, Goldman's Thomas Stolper, who is danger of once again appearing rather foolish with his 1.50 EURUSD call (despite the pair rising as high as 1.4925 earlier), and has a stop at 1.35, released another note in which he said that while Europe may be insolvent, things are not really all that bad. "It appears FX markets and the Euro play the role of a safety valve
with investors buying protection in case the sovereign situation gets
notably worse...Having said this, apart from the Euro, things seem to stabilise
otherwise. Greek 2yr yields have been stable, slightly below 24 percent
for about 3 weeks and this despite no peripheral bond purchases by the
ECB within the SMP program in recent weeks. Greek stocks appear to be
stabilising at low levels as well, having been on a downtrend for
several months....we remain structurally constructive on cyclical assets, including
stocks and oil, which in turn suggests there could be further upside in
the Euro, induced from cross asset correlations.
" Ergo, GS is now betting the ranch on a dead cat bounce which will lead the market dominating robots to an IMF like release of buying programs soon enough. And with that we have now seen it all.

From Goldman Sachs, "Still Constructive on the Euro"

1. Overview and Week Ahead

Last week was dominated by very nervous price action across asset classes. Bonds, stocks, commodities and many currencies traded in relatively large ranges without really breaking into new territory. The notable exception was the Euro which continued to decline in price against the USD.

After a few weeks with clearly disappointing releases relative to high expectations, last week's data was generally close to expectations. There have been a few notable positive surprises, though. Eurozone GDP numbers were boosted by a strong German and French GDP in the first quarter.

Special focus was once again on the Eurozone where the public debate on whether to grant Greece additional financial support, and under which conditions, continued.

This week will offer us more on that front with the Ecofin/Eurogroup meetings on Monday. Other than that, we have important cyclical data this week with the Philly Fed on Thursday standing out as the key forward-looking indicator. It will also be interesting to watch trends in initial claims, which has been volatile recently. Finally, Fed Chairman Dudley’s speech will be interesting to follow, together with FOMC minutes. Today’s TIC data will be important for our USD views.

2. Sovereign Concerns and the Euro

Obviously, the last couple of days have been dominated - once again - by the concerns about sovereign debt in Europe, and in particular in Greece. It appears FX markets and the Euro play the role of a safety valve with investors buying protection in case the sovereign situation gets notably worse. The latest IMM data indicates the notable drop in EUR longs and USD shorts as of last Tuesday. Since then, the skew in EUR/$ risk reversals has become more biased towards EUR/$ puts, which suggests that speculative positioning may now be outright short.

Having said this, apart from the Euro, things seem to stabilise otherwise. Greek 2yr yields have been stable, slightly below 24 percent for about 3 weeks and this despite no peripheral bond purchases by the ECB within the SMP program in recent weeks. Greek stocks appear to be stabilising at low levels as well, having been on a downtrend for several months.

Moreover, when looking at other peripheral countries, and in particular much larger Spain, we detect an increase in volatility and choppy ranges but little evidence of fear-dominated price action. The sovereign spreads between Spain and the core countries of the Eurozone has actually declined over the last week and remains well within the range seen throughout most of the year.

The fiscal adjustment in Greece is obviously painful and it is therefore understandable that there will be periods of reform fatigue. And during these periods, negotiations about additional support are understandable. We are going through one of these periods currently, but this does not change our underlying view that the Eurozone has the ability and will to deal with its problems.

Moreover, the news flow over much of last week indicates continued strong political commitment to Eurozone membership in our view. Together with the financial, fiscal and economic strength of the Eurozone as a whole, the situation in the small countries Greece, Ireland and Portugal is highly unlikely to be genuine threat to the Euro.

We once again come to the conclusion that the fiscal risk premium will likely decline after the recent increase.

On the other hand the rapidly approaching debt ceiling in the US, likely to be hit by the middle of summer, has the potential to lead to a notable increase in the Dollar's fiscal risk premium - in particular if the political haggling about the consolidation path continues without producing tangible results. Moreover, as the latest US Weekly highlights, substantial fiscal consolidation could leave the Fed in a position where rate increases would be unlikely for a very long time to come.

3. Growth Differntials and US BBoP Challenges

In terms of growth surprises in recent weeks, the Eurozone GDP data clearly stands out, with the core countries powering ahead. Moreover, as Dirk Schumacher has highlighted, strong growth in Germany leads to rapidly rising tax revenues, which is critical given its role as fiscal anchor within the Eurozone.

On the other hand, US activity data seems to be slowing gradually with weekly claims data in particular displaying a trend of rising unemployment again. Interestingly, this happens against the backdrop of renewed widening in the trade deficit. The combination of weaker growth and growing external US funding needs, make it likely that downside pressure on the USD will persist. Today's TIC data will be important given the last two releases have indicated continued weak equity inflows in particular.

4. Cross Asset Correlations

As described in the overview, price action last week has been choppy across asset classes but no evidence of broad based decline across cyclical assets. In that respect the EUR weakness again stands out. When looking at our FX Beta and Correlation Cruncher frameworks, it appears the EUR has undershot by about 2 percent relative to these cross asset benchmarks.

Moreover, we remain structurally constructive on cyclical assets, including stocks and oil, which in turn suggests there could be further upside in the Euro, induced from cross asset correlations.

Overall, we remain committed to our view that EUR/$ will move higher again. From a tactical trading point of view, it obviously hurts that we decided to not lock in potential gains when we almost reached our 1.50 target. But with our fundamental views still firmly in place we continue to remain positioned for a renewed EUR/$ rally.