Is The EUR Risk-On Or Risk-Off?

The slings and arrows of outrageous EUR positioning remain key to figuring out where next in this on-again-off-again currency. The last six weeks or so have seen a dramatic regime shift from smooth transitions from risk-on to risk-off to more staccato-like jumps and trends as the world hangs on every rumor and flashing red headline. We note three things that may be critical to understand where we go next: 1) EURUSD has entirely recoupled with its EUR-USD 'swap-spread' implied fair-value - removing the 'chaos premium' in the pair, and providing less room for upside without broad-market agreement; 2) EURUSD has decidedly lagged the very impressive rally in European sovereign risk (suggesting the latter may be a little over-exuberant); and 3) Despite every talking head telling you about 'all the EUR bears', both Commitment of Traders and Citi's FX positioning indicator have shifted notably more positive - with the latter, as Steve Englander notes, beginning to show significant EUR longs. Now that an active segment of the market actually seems long EUR and associated currencies, the 'good news' bar is a lot higher, and the impact of bad news will be more readily visible.


The relationship between EURUSD and the S&P 500 e-mini futures (ES) has become far more rapid in its regime shifting (lower pane is intraday correlation)...


EURUSD has for the third time since the epic crisis began, crashed and reverted to its EUR-USD 'swap-spread-differential' model fair-value. Notably each time has seen EURUSD sell-off significantly relative to swap-spreads (as FX positioning dominates any interest-rate carry drivers and 'stress premia' get priced in), then gradually swap-spreads will 'normalize' back down to the 'new levels, with a final flourish push higher in EURUSD to recouple with rates as the 'chaos' premium is removed. Also of interest is that in this downtrend from the middle of last year, EURUSD has been unable to sustain any positive premia to this rates-model as pressure always remains...


and in the meantime, European sovereign risk has rallied dramatically - diverging initially from EUR weakness but now EURUSD is catching up (albeit very gradually). We suspect (strongly) thatthe strength of the European sovereign rally (GDP-weighted in this chart) is overdone in very thin illiquid markets and the 'fair' value lies somewhere wider (as can be seen in the last few days that realization appears to be happening)...


and finally to positioning, where Commitment of Traders' data shows a significant push higher (squeeze) which led the rally - though obviously still remains negative.


and Via Steven Englander of Citigroup:

When we look at our CitiFX Access positioning indicator we are struck by the swing in fortunes of euro. In less than a month the euro and its traveling companions, CHF and, to some degree, GBP, have shifted from being currencies that everyone loved to beat, to beginning to show significant longs. In the chart below we plot the CitiFX Access combined position for EUR (light blue) EUR and CHF (azure) and EUR, CHF and GBP (dark blue). We combine EUR and CHF because there has been virtually no volatility over the last year, so it is realistic to view investor shorts in one or the other currency as excellent substitutes. We combined GBP with EUR and CHF, because it gives a good representation of core European currency positions.




Both are at their highs of the year, with the EUR and CHF combined position having swung massive in less than a month. The way to interpret the move from -3 to 0.75 is that the combined EUR and CHF short in late july was approximately three times the average position size (where we measure the position size in absolute terms,, setting aside whether investors were long or short). Now the long is 0.75 times the size of typical positions and by far the ‘longest’ of the past year. When we include GBP, the position swing is much less dramatic but still takes us to the longest joint long of the past year. The EUR positioning move has been similar but we think the combined positions are more relevant. (That said, the CitiFX Access data are probably most indicative of what active traders are doing.  Non-leveraged investors still appear to be short EUR, although less short than they were earlier this month.)


The timeliness of the CitiFX Access positioning data is an important advantage, as is its daily frequency. Our last observation is Wednesday Aug 22 so we can glimpse post-Minutes repositioning in the last observation. On Wednesday EUR+CHF longs as well as EUR+CHF+GBP longs went up by 0.5. More interesting is that this was just extending a move that began in earnest on Monday of this week. The EUR+CHF position went up by 1.18 and the EUR+CHF+GBP position by 1.75 (to put this more concretely, if the typical position size was 100, the swing over these three days was 118 and 175 in the long direction). This suggests that the renewed rumors of ECB bond market intervention earlier in the week were already having a major impact on positions before the Minutes were released, but it looks as if the FOMC extended the move.

We tend to view the first move from positioning extremes as the easiest one because the bar is so low for a reversal. Now that an active segment of the market actually seems long EUR and associated currencies, the ‘good news’ bar is a lot higher, and the impact of bad news will be more readily visible.


Charts: Bloomberg, Citi, and Capital Context