Presenting Six Views Of The EUR
As EURUSD leaks very gently lower into the new year (but stocks popped excitedly across quiet European markets that lacked a bond market supervisor to keep them honest), we thought it might be interesting to look at the relative strength of the Euro against six different measures. From FX option risk-reversals to ECB's European Bank Lending statistics, QE and sovereign risk relationships to Fed/ECB balance sheet dynamics, and finally from futures commitment of traders data to EUR-USD swap spread frameworks, the results are unsurprisingly mixed with a bias towards EUR weakness.
1. This chart shows the relationship between EURUSD option risk-reversals (a complex way of saying investor's bias towards puts or calls). The last few weeks has seen the risk-reversal (bias) shift 'bullishly'. Now back 'in line' with its longer-run relationship we call this one EUR 'neutral' but can't help but see a trend of modest bullish EUR evolving.
The next three charts all relate to the dynamics of the ECB and Fed balance sheets...
2. The relationship between ECB's balance sheet lending to European credits (black) and the EUR has been discussed a number of times recently and suggests further EUR weakness.
3. The Fed's QE2 program had an interesting impact on the relationship between EURUSD and European Sovereign risk (in this chart shown in black measuring the GDP-weighted-average spread of the 17 European nations). During non-interventionist periods (fewer and fewer recently), the two correlate very highly which given the current environment would suggest a weaker EUR perspective. If the periods 1, 2, and 3 are investigated standalone - the fit is incredibly close - and then the QE rumor and news periods dislocate the dependence.
4. Aggregating across the Fed and ECB's balance sheet, we see the now-familiar highly correlated 'chart-of-2012' that points to significant EUR weakness in the short-term as the ECB implicitly prints (via LTRO). This of course then infers a reaction by the Fed (to 'weaken' the USD) especially in an election year given its correlation-impact on US equities.
5. Moving away from more fundamental based drivers of the EUR vs USD relationship once again, we note the now all-time record high net short interest in EUR futures (commitment of traders) - which until we see a turn is not bullish for the EUR (in a contrarian way) and in fact points to further EUR weakness (perhaps the levered futures market is front-running the much bigger real-money exit that would drive the EUR down?).
6. And finally, we look at the swap-spread model that has been a main-stay of relative-value trading for a considerable period. By tracking the entire swap curves of EUR and USD, we find a strong relationship (which makes fundamental sense obviously in terms of rates) between this model and the market's EURUSD rate. This relationship saw a EURUSD depreciation and rally-convergence in September 2011 and we are once again at about the limit of the model's disconnect (green histogram). The last few days has seen the swap spread model starting to push higher and this framework would suggest a positive EUR bias (we would prefer the RV trade as opposed to outright though).
So in summary we have FX options that have a EURUSD neutral bias (with maybe a hint of EUR bullishness), Swap spreads that have a EURUSD positive bias, EUR Futures Commitment of Traders data that suggest EUR weakness (though arguably that is the pain trade and EUR strength is more contrarianly likely), two central bank-related indications that we should see further EUR weakness, and sovereign credit spreads that further suggest EUR weakness.
[We can't help but see a case for EUR strength from this data - FX options vol biasing higher, swap-spreads biasing higher, and futures shorts way over their skis? this is balanced against sovereign risk weakness and central bank dynamics that suggest EUR weakness]
Of course, all of this depends on the words that come out of Bernanke's mouth on the 24-25th of January (though we suspect without considerable economic malaise in the next two weeks, a major LSAP announcement would be hard to justify). Of course, the next two weeks have some rather worrisome (in size and origin) supply and redemption issues for European sovereigns and judging by last week's sovereign credit risk performance, bond markets are not excited about it.