Article / 23 November 2012 at 15:19 GMT

EURUSD heads higher, unfazed by event risks

John J Hardy John J Hardy
Head of FX Strategy / Saxo Bank
Denmark

Market ignoring all of the coming risks for Europe as the painful direction for the market remains to the upside in EURUSD and EURJPY.

The markets seem to believe in magic for the moment on Europe – as tail risks continue to fall while there is no new sign that a longer term solution is on the table for Greece or the rest of the EU periphery. No matter – the market tells its own truth, and as long as the market is able to write off the long term risks of social tensions at the periphery (the tail risks) and as long as the ECB is effectively prohibited by the EU framework from the kind of monetary policy measures that are possible from the BoE, the US Fed, and what is increasingly being anticipated from the BoJ, the Euro risks trading higher, particularly as positioning has been caught on the wrong foot by the break below support recently.

Chart: EURUSD
EURUSD is swinging through the final resistance levels that barred its re-entry into the previous range, and this could be the setup for an even larger move higher assuming this weekend’s Catalonian regional election and whatever emerges from Greece early next week fails to reintroduce EU tail risks. Positioning is not ready for a move back higher after the recent move lower proved a head-fake. The next key is the psychological pivot at 1.3000, which was pivotal for most of September and October as well. Above there, and the 1.3170 resistance may not stand a chance, so we have to project 1.33-13500 range, thought that much USD weakness will also require that the fiscal cliff proves a mere fiscal blip and that the equity market pushes back towards the highs for the cycle. These kinds of level are absurd and unsustainable, but they’re not impossible in the short term under the right conditions.

eurusd

Looking ahead
As indicated in the chart caption above, the immediate focus is on this weekend’s Catalonian regional elections and whether we eventually see a constitutional crisis in Spain based on a move toward the new leadership in Catalonia for a referendum on independence for the region. Looking at Spain’s spreads, the market isn’t at all bothered for the moment, so it may remain a longer term question. Then it is on to what kind of deal, if any, has been hammered out for Greece. One would think that debt forgiveness and restructuring would be the most Euro-beneficial for the Euro crosses, though it would lead to longer term questions over other the solution for other periphery countries.

Elsewhere, next week we get down to political “fiscal cliff” business again in the US as most of the US has taken a 4-day weekend if we include today and yesterday’s Thanksgiving holiday. The rhetoric seems awfully optimistic there relative to potential pitfalls, but let’s see what develops. The latest indications from Republican House Speaker Boehner is that he is would like to see “Obamacare” on the table as a bargaining chip in the fiscal cliff negotiation process. The tax cut side of things could get far more controversial than the spending cut “sequester “ portion, which will likely be quietly agreed on as all politicians, regardless of their affiliation, like to see federal spending in their local district.

Also, look out Monday for the BoJ minutes, which could hint at what the BoJ is pondering for future easing – particularly if foreign assets are on the table. The bigger focus remains on what the political leadership plans to do in terms of appointing a new BoJ leader and pushing on the fiscal stimulus side of things among other measures to weaken the JPY . Shinzo Abe, the likely new LDP Prime Minister next year after the Dec. 16 lower house elections, has been explicit in encouraging a full engagement in competitive devaluation and has even proposed at JPY 200 trillion stimulus package, which would represent over 40% of GDP. Compare that with Obama’s first stimulus that was around 5% of GDP. The numbers boggle the mind.

Economic Data Highlights (all times GMT)

  • Germany Nov. IFO Survey out at 101.4 vs. 99.5 expected and 100.0 in Oct.
  • UK Oct. BBA Loans for House Purchase out at 33.0k vs. 32.0k expected and 31.5k in Sep.
  • Canada Oct. Consumer Price Index out at +0.2% MoM and +1.2% YoY vs. +0.1%/+1.1% expected, respectively and vs. +1.2% YoY in Sep.
  • Canada Oct. Core CPI out at +0.3% MoM and +1.3% YoY vs. +0.2%/+1.2% expected, respectively and vs. +1.3% YoY in Sep.

Upcoming Economic Calendar Highlights (all times GMT)

  • Japan BoJ’s Shirakawa to Speak (Mon 0100)
  • Japan BoJ Minutes released (no time given)
1y
benlouro benlouro
and the thing is: the more EUR will move up... more problems will Europe face going forward. Club MEd countries can not hold with: strong currency, high cost of finance, high unemployment. This is a cliff coming!!
1y
Umbeluzi Umbeluzi
Risk button is on because players are eternally betting on a miracle solution from night to day. Till there, if one want to earn something, must surf the trend until it reverses...
1y
Brightu Brightu
@ Umbeluzi,i agree with u, surf the trend...
1y
John J Hardy John J Hardy
"surf the trend" might be unfortunate metaphor - as waves can crash....but I am firm believer that one should never fight the market - particularly when "the story" points one way, but the market goes another...
1y
Umbeluzi Umbeluzi
Disconnect between fundamentals and markets is a very old story! From stocks to oil, to forex, and so on :)
1y
Juhani Huopainen Juhani Huopainen
Any apparent disconnect between markets and fundamentals usually means that the fundamentals have already long ago been priced in - and too much so. The other alternative is that the assessment of the fundamentals is wrong. Only very rarely, and with exceptionally good reasons, should price action be dismissed.
1y
Rcernava Rcernava
When the market exploded down fearing fiscal cliff melt down and sudden Greek default with no bailout.. The reaction was very aggressive and overly played. Just like now the market in short cover frenzy + thin markets is overly confident in a complete Greek deal and no fight over US fiscal reform. I've been calling this nonsense for a long time on Aussie. Patience is needed for TRUE fundamentals to play out!!
1y
Juhani Huopainen Juhani Huopainen
Again my old hint: drop the chart on the floor and stand on the table: weekly chart says the whole eurocrisis has been spent in a historically narrow EURUSD range of 1.2-1.5, current upside target 1.40-1.45. Now that would surprise us all.
1y
Umbeluzi Umbeluzi
@Juhani Huopainen, good point for position traders! Only for processing the idea, wich suitable instruments, other than spot market, to invest in such a wider time frame ? Thanks.
1y
Juhani Huopainen Juhani Huopainen
I'll think about this. A call option on EURUSD is still a good choice as option volatilities are historically very low now. Exotics don't make much sense, as barrier options do not lower the premium by much. Would not be an option seller at current vols, so risk reversals or seagulls don't interest me.
1y
Umbeluzi Umbeluzi
@Juhani Huopainen, thanks. My preliminary thinking point to instruments capable of playing medium term swings without such inconveniences of time decay and leverage.
1y
Juhani Huopainen Juhani Huopainen
a bought option actually has "negative leverage", as the delta of the option is below one in any possible case. When using bought options, one way to try to minimize the time decay is to use longer maturity than what your trading window is like: i.e. if you expect the move to happen in the next three months, go for a six-month option instead - by the time the three months are over, the option still retains plenty of its original time value. Also, the vol curve is not that steep between the 3 and 6 months currently, so loss-of-vol due to passage of time is minimized. Bought options are always also plays on higher option volatility, and currently the vols are cheap. Finally, risk reversals are still pricing EUR call slightly cheaper (over puts).

I am not stating that the EURUSD will definitely go to 1.40. But given the sentiment and the recent years' price history, it is not that far-fetched scenario. What if 2013 H1 will be like 2011 H1?
1y
Rcernava Rcernava
Vols are on the floor, sub crisis levels. If anything vols show us how complacent this market has got. Historically each time this market has gotten in this place a twist in the story has found the market off guard.
1y
Juhani Huopainen Juhani Huopainen
The "true fundamentals" question is an interesting one. How's this for a working hypo: everyone knows that US will target inflation, and it will pick up, while yields remain low = negative real carry. Probable thing is that Europe still "does not get it", and will continue austerity, pinballing with Greece and slowly moving towards a minitransferunion with lots of mutualized debt in the rescue vehicles. All this leads to deflation as monetary policy does not transmit and ECB does not get permission to perform proper inflation targeting from Germany. So a quick back-of-the-envelope could place the coming real carry differential between US and Euro around 3-4% p.a.?
1y
Rcernava Rcernava
If the ECB is ineffective this would simply raise the fear of emu melt down. With out a mutualized debt the emu is not truly united and it is only a matter of time before austerity brings deep civil unrest(referendums will be flying). FED has not been effective in the transmission of their policy. QE has caused only short term inflation and with the peddle all the way down we would need the blockages cleared to see inflation really take hold, until then I remain skeptical. In the US there is even a chance austerity we be taken (p.a. on commodities and high beta?).
1y
Peter Bukov Peter Bukov
EURUSD at 1.4250 would push SPX to 1600. And that just cant happen, or can it ?
1y
Juhani Huopainen Juhani Huopainen
IF the SPX/EURUSD correlations continues... Again - fading the news and the state of the world, that is the range the market has traded during the euro crisis. Was Spain and Greece's coming total default totally unheard of during the highs of the ranges? No. What if some sort of debt mutualization is done, and what if haircuts to crisis countries' debts are made, and ECB begins to act as a true LOLR? Not impossible. The European story is now as bad as it can be - and we already visited 1.31 on the promise that ECB will buy short duration Spanish bonds after bailout agreements. This is just a scenario that I keep in my mind...
1y
Umbeluzi Umbeluzi
@Juhani Huopainen, thanks for the above answer regarding options. Still processing the idea although it is a bit early to jump in such time frame trade before more clarification on Fiscal Cliff implications and further developments on Spain and Italy, since my understanting is Greece is not a real serious threat to Euro. What is your opinion? Thanks.
1y
Juhani Huopainen Juhani Huopainen
I believe politically Greece will break the euro. The politicians have been very careful not take losses, and they have managed to roll their position. But now bailout of Cyprus will mostly involve losses from the Greek gov bonds. When Greece will burn the euro, I don't know. My bet is after the German elections. Merkel's re-election campaign is surely the most expensive political campaign in the history. Whole Europe in deflation because of bad recall of history (it was austerity and fixed rate that killed Germany and caused hyperinflation, not the other way around)

Spain's dilemma is that it will not ask for a bailout before it really, really needs one - and the terms are always the worst at that point. The recent move in EURUSD is partly because it looks like Greece will be given more time (solved for now), and the US fiscal cliff risk is on. But to take the market much higher from here, something else is needed as well.
1y
Umbeluzi Umbeluzi
Greece can do serious damage to euro if they exit from european union. But the central powers don't let it to happen, otherwise russians will go onboard into this NATO country. Remember, greeks has an yet unexplored big oil reserves. Believe, it is a real chess game!
1y
Juhani Huopainen Juhani Huopainen
I calculated the reserves, they are not even enough to cover Greece's annual budget deficit - but they could help a lot.
1y
Umbeluzi Umbeluzi
Ok, tomorrow there is another battle. I'm going to rest. Thanks for your responses!
1y
Juhani Huopainen Juhani Huopainen
good night!
1y
Umbeluzi Umbeluzi
Good night!
1y
Rcernava Rcernava
Germany is playing with Greece and eventually the inevitable will happen either voluntarily or involuntarily. This undoubtedly would destabilize the euro zone.

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