As SocGen's Kit Juckes writes in his daily FX note, the currency market has been a "mess to end May", noting that the month is ending on mixed note, but the themes of the month are pretty clear: the Euro and its satellite currencies were the big winners this month, benefitting from decent economic data, reduced political risk and a focus on the ECB’s timorous exit from crisis policy settings. The big losers were the Brazilian real (politic) and Sterling (politics). In between that lot, the ZAR benefited from political optimism, NZD from higher milk prices, AUD suffered from weak iron ore prices and JPY has held up reasonably well, just as the dollar has struggled somewhat under the weight of depressed bond yields.
Looking at the Euro specifically, Juckes writes that the common currency rally is being slowed down by the build-up of big long positions, the gap between how far the currency has gone and the move in relative yields, and the rhetoric of the ECB President. All of which argue for buying a corrective dip which hasn’t really happened yet. The pull-backs so far have been modest, testimony to the underlying strength of the upward trend. EUR/JPY has disappointed of late, after rallying sharply from mid-April to mid-May, but it remains the most attractive Euro long other than EUR/GBP.
Further, the SocGen strategist higlights the importance of politics as a market driver which "can’t be overstated."
Perhaps that shouldn’t surprise anyone when the economic backdrop is relatively dull. This morning, the pound is the main victim again as a YouGov poll points to a possible hung parliament as the Conservatives risk losing seats in next week’s election. We're supposed to treat polls with suspicion but needless to say, we remain bullish of EUR/GBP even if I’ve lost my bet that it would trade above 0.90 by the start of this week. Market positioning is much cleaner now and relative yield trends are friendly.
And yet speaking of the euro, anyone who was waiting for a more sustainable correction may have missed their chance according to Bloomberg's Mark Cudmore who writes that "if you blinked, you missed the Euro correction." His full thoughts below:
Yesterday morning, my inbox was full with reasons to sell the euro. It duly traded sharply lower before subsequently ending the day higher. I think the correction may be over already.
When the consensus is for a dip that everyone wants to buy into, that dip tends to be both brief and shallow. Further, the main fundamental reasons for a pullback were either negated or weak to begin with.
Reports in Germany that Greece would reject its next bailout payment were denied by the government. Dovish Draghi comments were countered by a Reuters report that the ECB’s statement will remove the mention of downside risks.
Just because Italy is close to approving a new electoral law doesn’t mean that early elections will definitely be called. It’s the Italian president’s prerogative and he is reported to be against the idea. Italy is a valid risk to be aware of but the shift this week was incremental and not too relevant.
In the wake of Tuesday’s disappointing German data, today’s Euro zone inflation print carries downside risks, but any related pressure on the euro may not sustain. Investors know that there’s no hint of runaway inflation in the euro zone and monetary policy isn’t the main reason to buy the single currency.
Instead, it’s the growth recovery story -- highlighted by BlackRock’s Larry Fink. The region’s latest manufacturing PMI was the highest in at least three years.
It’s also about the removal of tail-risk pricing. The euro zone has survived the worst that could be thrown at it and the narrative of the currency union breaking up is stale.
Euro implied volatility has slumped as a result – it’s now perceived to be the third-most stable G10 currency, after CAD and CHF, versus the dollar based on such metrics. The euro can be a haven currency again.
This combined narrative of growth and haven appeal is powerful, and flows should continue to be supportive for the euro over the medium term. A new 2017 high beckons.